The passing of a loved one is always an emotional time and a time to reflect and celebrate that person’s life. There are, however, still practicalities that need to be dealt with and one of these is sorting out the inheritance of the estate and any tax implications that this might have on those inheriting a part of the estate. In this article we will take a look at the inheritance tax rules as well as how they apply to properties, which most often, has the largest value.
What is Inheritance Tax?
Quite simply it is a tax that the Government levies on the assets that someone leaves behind when they pass away. This includes cash, shares, properties and any possessions. At its most basic, anything that has a value is an asset and if it is left to someone then it will form part of the inheritance tax threshold.
Inheritance tax is only payable if the value of the assets is more than £325,000 and anything above that is taxed at 40%. So, if the assets are worth £425,000 then the estate pays inheritance tax on £100,000, which at 40% is £40,000.
It is important to remember that the value of an estate’s assets includes looking at debts so if someone’s assets are worth £400,000 but they have debts of £100,000 then the estate’s value is £300,000 and so not liable for inheritance tax.
The legalities around inheritance tax are more complex than that though. For a full description of inheritance tax and the rules around it visit the Government’s website.
Properties are likely to be the biggest value item in any estate and there are specific rules around properties which could reduce the amount of inheritance tax that needs to be paid.
If the property is left to a spouse or civil partner then there is no inheritance tax to pay at all. If your total estate is worth less than £2 million and you leave it to either your children or grandchildren then the threshold for inheritance tax rises to £500,000. The reason for this is that the Government applies what is called the Residence nil-rate band. This is an additional tax-free allowance on top of the £325,000 meaning that no tax is paid on the first £500,000 of the property’s value.
For estates over £2 million the nil rate band decreases by £1 for every £2 over £2 million, so if the estate is worth £2.35 or more the Residential nil rate band is £0 and inheritance tax is paid on anything over the normal £3250,000
If someone passes and leaves their entire estate to their spouse or civil partner then they have used none of their inheritance tax allowance. In this instance the allowance passes on the surviving partner. This means their tax-free allowance essentially doubles and if they leave the property to either the children or grandchildren then the total tax free allowance rises to £1 million.
There are specific rules around general gifts such as cash gifts and to see what they are, please visit the Government website. In this article we will focus on gifting a property, which is also perfectly acceptable and, if carried out according to the rules, could mean no inheritance tax is due. Properties can be gifted away and no inheritance tax would be payable if the person who made the gift moves out and lives for at least another 7 years. If the person passes within that 7 year period then the property becomes a gift under the 7 year rule and is treated accordingly for inheritance tax. It is important to note that the person must move out for this to be treated as a gift which does not incur inheritance tax. Should the person stay rent free in the property then it becomes a gift with reservation and is subject to inheritance tax. If, however, full market rent is paid on the property to the new owner, this is reviewed regularly and the person who gifted the property lives there for 7 years, then no inheritance tax is payable.
Inheritance tax law is very complex and there are some perfectly legal ways to reduce the amount of inheritance tax that needs to be paid and we strongly advise seeking professional advice whenever it comes to matters concerning inheritance tax.