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  1. Blog
  2. How to avoid Inheritance Tax on property
House selling tips
03 December 2021

How to avoid Inheritance Tax on property

Sam Edwards
Writer
Grandchild playing with a child at the dinner table.

Table of contents

  1. 1. How to avoid Inheritance Tax on property
  2. 2. Nil Rate Tax Band and Residence Nil Rate Band
  3. 3. Passing property before death
  4. 4. Nil rate transfer bands
  5. 5. Can I give my house to my child to avoid Inheritance Tax?
  6. 6. How much money can be legally given to a family member as a gift?
  7. 7. How much can you inherit without paying Inheritance Tax?
  8. 8. When do I not need to pay Inheritance Tax?
  9. 9. When do I need to report an inheritance to HMRC?
  10. 10. Can you put your house in trust to avoid Inheritance Tax?
  11. 11. What is a property protection trust?
  12. 12. Trusts and Inheritance Tax
  13. 13. FAQs

Inheritance Tax (IHT) is a tax on the estate (the cumulative monetary value of property, possessions and money) of someone who has died. The tax has sizable implications, with the estate being liable for 40% of the amount it exceeds the £325,000 threshold. What’s more, IHT must be paid within six months of the decedent’s date of death, meaning there’s little leg room for workarounds.

Naturally, it’s in your interest to limit the amount of tax you pay on any property you inherit. Thankfully, you may not even need to pay IHT at all.

How to avoid Inheritance Tax on property

Unfortunately, you can’t avoid Inheritance Tax because you’re legally obligated to declare any inheritance you receive through HMRC. However, you can reduce the amount that you owe, often to the point of owing nothing at all. There are several ways you can legally do this.

Nil Rate Tax Band and Residence Nil Rate Band

Nil Rate Tax Band

Inheritance Tax is charged on estates worth over the Nil Rate Tax Band, which in 2021/2022 is £325,000. Anything over £325,000 is usually charged at a 40% rate, but this can be reduced to 36% if 10% or more of the estate is left to charity. If an estate exceeds £325,000 but everything is left to a spouse, civil partner or charity, no IHT will be charged.

As of September 2021, the average house price in the UK is valued at £269,945. This means most people will be pushed above the Nil Rate Tax Band threshold when factoring in the rest of their estate (money, possessions). Thankfully, there are legal allowances available that can help.

Residence Nil Rate Band

Introduced in 2017, the Residence Nil Rate Band (RNRB) works as an extra allowance for those inheriting property with IHT to pay. The band takes some of the value of the main residence out of the estate. This means you might not have to pay any IHT at all.

As of 2021/22, the RNRB is £175,000 till the tax year of 2025/26. In practice, this gives estates a Nil Rate Tax Band threshold of £500,000 (£325,000 + £175,000) before any Inheritance Tax needs to be paid.

Remember: RNRB can be used on only one property in a decedent’s estate. If there are two properties in the estate, only one can have £175,000 removed from its value.

How to avoid Inheritance Tax using the Nil Rate Band and RNRB

While estates (with property) valued at £500,000 can expect to pay zero Inheritance Tax through the RNRB allowance, there’s a way to increase this threshold up to £1 million.

When a spouse dies, their partner inherits their Nil Rate Band threshold (£325,000), as well as their RNRB (£175,000), making for a grand total of £500,000. This means the final partner’s death could result in an estate, valued at £1 million, being passed down to beneficiaries free of IHT.

RNRB gradually reduces for estates worth more than £2 million, even if the home is left to direct descendants. It reduces by £1 for every £2 the estate is worth over the £2 million threshold. Direct descendants are defined as children, grandchildren and guardian children. Nieces and cousins are exempt from direct inheritance criteria.

Passing property before death

Another way to reduce Inheritance Tax is by passing property ownership onto beneficiaries before death. Legally registering your home under your child’s name for example, will take it out of your estate. This will reduce your estate’s cumulative value, and hopefully mitigate Inheritance Tax. However, there are strict rules around this - specifically, the Seven Year Rule.

Seven Year Rule

As its name suggests, the Seven Year Rule applies to the period of time between the transfer of property and the original owner’s date of death. If the original owner dies seven years after the transfer, the new owner of the property will not be liable for any Inheritance Tax, as the property will not register as part of the decedent’s estate.

However, the Seven Year Rule also requires that the new owner pays the original market rate or mortgage. Otherwise, they will be treated as a beneficial owner, and the property will remain as part of the estate.

If the original owner of the property dies within seven years of giving their home away, it will be treated as a PEP (Potentially Exempt Transfer) and form part of the estate within the Nil Rate Band of £325,000.

The value of any gift above the £325,000 threshold will have an IHT rate applied depending upon when the gift was made. The earlier a gift was made, the lower the rate:

Nil rate transfer bands

  • Below £325,000 or 7 years: Nil
  • Above £325,000 or 1 - 2 years: 40%
  • 3 - 4 years: 32%
  • 4 - 5 years: 24%
  • 5 - 6 years: 16%
  • 6 - 7 years: 8%

Can I give my house to my child to avoid Inheritance Tax?

You could, but this depends on a number of factors. For your gifted property to be exempt from Inheritance Tax, it must:

  • Be valued below £325,000 (or £650,000 for married couples).
  • Be gifted seven years before your death.

Furthermore, the property must be gifted unconditionally. This means if you, as a parent, benefit in any way from the property, the gift will be deemed a Gift with Reservation of Benefit (GROB), and will remain in the estate. So, if you decide to give your home to your children, but continue living there, the gift will still be taxed as part of your estate.

There are two ways around this issue:

  1. You could rent the property back from your children and continue to pay rent at the market rate. Paying less than the market rate will make your home remain in your estate and subject to Inheritance Tax.
  2. You could gift half of your property to your children and split the bills evenly. Their half of the property would no longer be subject to Inheritance Tax.

In both these scenarios, you would have to live for seven years for the gifted property to be exempt from Inheritance Tax.

Alternatively, you could sell your property to your children at a cheaper market rate. The discount would not only be viewed as a gift, but be exempt from IHT after seven years.

How much money can be legally given to a family member as a gift?

You have an annual allowance of £3000 for gifts to family members without tax implications. If the cash gift is higher than £3000, you will need to declare it with HMRC. However, you won’t have to pay any tax unless the gift-giver dies within seven years of transfer.

Exempted gifts include:

  • Wedding or civil ceremony gifts
  • Small gifts (up to £250 paid from regular income)
  • Donations to charity
  • Gifts to cover living expenses

How much can you inherit without paying Inheritance Tax?

You can inherit £325,000 or an estate worth £500,000 without paying Inheritance Tax. If you inherit more than £325,000 you will need to pay tax. Anything over this threshold is charged at a rate of 40%. If the estate includes property, this threshold rises to £500,000 (or £1 million for married couples). If your spouse dies, you won’t be charged Inheritance Tax on anything you inherit.

When do I not need to pay Inheritance Tax?

You don’t need to pay Inheritance Tax if:

  • The estate is worth less than £325,000
  • You received a property (less than £325,000 or £650 million for married couples) from a direct relative more than seven years ago
  • You were gifted less than £3000 in a single year
  • Your parent sold you their home at a cheaper market price

When do I need to report an inheritance to HMRC?

You need to notify HMRC once you receive your inheritance, even if there’s no tax due. If there is tax due, you will need to pay within six months of the decedent’s date of death.

Luckily this can all be done online:

  1. Visit the Gov.UK Inheritance Tax page.
  2. Click ‘I want to register so I can tell HMRC about a person’s estate’.
  3. Follow the steps.
  4. If the estate is worth more than £325,000, you will need to fill out an IHT400 form and send it to Inheritance Tax, HM Revenue and Customs, BX9 1HT.

Can you put your house in trust to avoid Inheritance Tax?

Setting up a property protection trust won’t mitigate Inheritance Tax completely, but it could reduce the amount you pay. However, without the guidance of an experienced financial advisor, a trust could leave you paying much, much more.

What is a property protection trust?

A property protection trust is a sanctuary created in the event of death in order to protect a child’s share of inheritance. To explain how a trust works, let’s use a hypothetical scenario. If you die and your spouse goes into care, local authorities will only be able to target the 50% share of property owned by your spouse (as tenants in common). Your share, or rather, your child’s share, remains untouched inside the trust. This also means this share will be protected from Capital Gains Tax.

Trusts and Inheritance Tax

Many people assume trusts protect estates from Inheritance Tax, when in fact, they don’t. When you create a trust, you must pay 20% IHT if your assets exceed £325,000. You will need to have your assets revalued every 10 years, alongside a further 6% IHT taxation.

IHT is incurred a final time when the trust is closed or the assets are removed. This tax is based on the most recent valuation with up to 6% charged on a pro-rata basis.

NB: All Content on this site is information of a general nature and does not address the circumstances of any particular individual. Nothing on the GetAgent site constitutes professional and/or financial advice

FAQs

What is the Nil Rate Band and how does it work?

The Nil Rate Band is a threshold for Inheritance Tax. Estates that exceed the threshold are liable for up to 40% Inheritance Tax. The current 2021/22 threshold is £325,000.

How much is Inheritance Tax on property?

The standard rate of Inheritance Tax (IHT) is 40% of the amount you exceed the current Nil Rate Band of £325,000. If an estate is worth £600,000, you would be liable for 40% IHT of £275,000 (£600,000 - £325,000), which is £11,000.

What counts as part of my estate?

Your estate is your total wealth, including all lands, property, possessions, money, and other financial assets.

At what age can a child inherit property?

You can inherit a property at any age but a minor can only come into possession of property once they reach 18 years of age in the UK.

Who pays Inheritance Tax?

The executor of the will is responsible for arranging the payment of Inheritance Tax. If you have inherited one part, or the entirety of an estate, you will be charged 40% on however much the estate exceeds the threshold of £325,000.

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