Understanding Inheritance Tax on Property in the UK

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Understanding Inheritance Tax on Property in the UK

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The information provided in this article is for informational purposes only and should not be construed as professional advice. Please rely on a lawyer for direct advice.

We are not liable for any actions taken based on the content herein and you should always refer to governmental sources and the Inheritance Tax Act to make final decisions. Cozee Properties are not lawyers or solicitors and you should not rely on the information in this article to make a financial decision

Inheritance tax is a levy imposed by the government on the estate of a deceased person before it can be distributed to their beneficiaries. The tax was introduced to prevent the accumulation of wealth within families and promote social mobility.

According to data from gov.uk, in the tax year 2020-2021, 3.73% of UK deaths resulted in an inheritance tax charge. In this article, we go over how the tax works and how to pay it if you are part of this figure.

Overview of Inheritance Tax on property

To begin finding how and if you should pay inheritance tax in the UK, it is useful to begin looking at what an estate is and how property is looked at in relation to the rest of the deceased assets.

What is an estate?

In the context of inheritance tax, an ‘estate’ refers to the total value of all the assets and possessions that a person leaves behind after they pass away. This includes everything from property and investments to personal belongings and savings accounts.

For the purposes of calculating inheritance tax, the estate encompasses all the assets owned by the deceased at the time of their death, minus any outstanding debts and liabilities.

Why is it important to know the value of an estate?

The value of the estate determines whether inheritance tax is applicable and, if so, how much tax is owed and is typically worked out by a tax lawyer or solicitor.

What must be included to find the value of an estate?

Numerous assets within the estate of the deceased must undergo valuation for inheritance tax (IHT) purposes, encompassing (but not restricted to):

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  • The money in bank accounts
  • Shares and stocks
  • Pension left behind and unused
  • Jointly-owned assets
  • Property
  • Jewellery
  • Vehicles
  • The remaining value of any debts
  • Insurance policy payouts

In essence, all monetary holdings, properties, and personal possessions of the deceased must be included to find out the tax owed on property, even if property carries the most significant value of the estate.

Where do you pay inheritance tax (IHT)

Inheritance tax, also known as the ‘death tax’ or ‘IHT’ is governed by the Inheritance Tax Act 1984, which outlines the rules and regulations surrounding the tax.

To begin the process of paying, obtain a payment reference number using this link

Once you have a reference number, how can you make payment?

Begin with one of the methods listed below to make payment that you can also find on gov.uk here.

A man paying his inheritance tax in the UK
  • Authorise a payment via your online banking platform
  • Initiate an online or telephone banking transfer
  • Conduct the transaction at your bank or building society branch
  • Send a cheque via postal mail
  • Withdraw funds from the deceased’s bank using a Direct Payment Scheme
  • Use British government stock
  • Transfer ownership of national heritage property

Who pays the inheritance tax to HMRC?

The tax must be paid by someone working on behalf of the deceased who is a relative or an executor who is responsible for dealing with the deceased’s tax affairs if no relative has been appointed.

This total tax amount can be easily worked out prior to the death of an individual through a will and after the death of someone with a large estate, they can then begin the process of obtaining a payment reference from HMRC.

Paying inheritance tax as a relative

When an individual drafts a will, they typically designate a personal representative (PR), which is usually a family member, to oversee the administration of the deceased’s estate.

The PR bears the responsibility of applying for the right to manage their estate (probate), ensuring adequate funds are accessible to settle any outstanding debts and paying inheritance tax.

It is not mandatory for this individual to be a relative, the task can be given to an administrator to do this process on a relative’s behalf.

Paying tax as an executor or adminsitrator

If there is no will, an executor should manage inheritance taxes, the executor (appointed automatically by the government) will become responsible for arranging the payment of inheritance tax to Her Majesty’s Revenue and Customs (HMRC). ‘

HMRC clock

How long do you have to pay Inheritance Tax?

Inheritance tax must be paid within six months of the person’s death. Failing to meet this deadline can result in interest charges being levied by HMRC.

This tight timeframe often catches people off guard, as the probate process (the legal procedure for administering the deceased’s estate) can take several months or even longer to complete.

HMRC will usually start charging interest once the six-month period has elapsed. To avoid this, one option is to pay a portion of the tax within the allotted time, even if the estate has not been fully valued. This can help alleviate the financial burden and prevent potential penalties.

Explanation of IHT thresholds

The UK government has established various exemptions and thresholds to ensure that not all estates are subject to inheritance tax so as to not tax the smallest estates too much.

Nil rate band threshold

One of the key exemptions is the nil-rate band, which is the value of an estate that is exempt from inheritance tax. In the 2023-2024 tax year, the nil-rate band stands at £325,000. If the value of an estate is below £325,000, no inheritance tax is payable.

However, if the value exceeds this threshold, the excess amount is subject to an inheritance tax rate of 40%. Here is how a typical inheritance tax calculation may look for someone with a total property and asset value worth over the threshold.

Item Amount (£)
Estate Value £500,000
Nil-rate Band £325,000
Taxable Amount = (Estate Value – Nil-rate Band) £175,000
Inheritance Tax Payable (Taxable Amount × 40%) £70,000

Residence Nil Rate Band threshold (RNRB)

The Residence Nil Rate Band (RNRB) is an additional allowance that can be claimed when passing on a main residence to direct descendants, such as children or grandchildren.

This allowance is intended to provide additional relief from inheritance tax for families inheriting their primary home and adds an extra £175,000 on top of the original £325,000 nil rate band.

Item Amount (£)
Estate Value £600,000
Nil-rate Band (exempt) £325,000
Residence Nil Rate Band (exempt) £175,000
Taxable Amount = (Estate Value – (Nil-rate Band – Residence Nil Rate Band)) £100,000
Inheritance Tax Payable (Taxable Amount × 40%) £40,000

Explanation of IHT exemptions

It is important to explore your options for exemptions from tax in advance as some of these methods have to be organised prior to the death of an individual, to begin gift giving is an exemption.

The exemption of giving gifts

Giving gifts must be done prior to the death of someone with an estate so it is.

The UK government allows individuals to make gifts during their lifetime without incurring inheritance tax, provided they don’t pass away for seven years after making the gift, incentivising gift giving in advance.

This is known as the seven-year rule and is better explained by the table below. Every year, there is a £3,000 allowance that can be given to heirs every year.

Time between date of gift and date of donor’s death Inheritance tax rate on the gift
0-3 years 40%
3-4 years 32%
4-5 years 24%
5-6 years 16%
6-7 years 8%
More than 7 years 0%

Giving gifts to a spouse or civil partner

Certain presents are not subject to Inheritance Tax.

No Inheritance Tax is applicable to gifts exchanged between spouses or civil partners. You are permitted to give them any amount during your lifetime, provided that:

  • They permanently reside in the UK
  • They are legally wedded to you or in a civil partnership

Similarly, no Inheritance Tax is due on gifts made to charities or political organizations.

a couple who have given eachother gifts for IHT

Giving gifts to those outside of your family

There is no tax applicable to be paid when giving gifts to anyone related or not, as long as the gift is unde £250 and you haven’t given them any other type of gift using another exemption.

Giving gifts to someone who is getting married or forming a civil partnership

In each fiscal year, you have the opportunity to offer a tax-free gift to individuals embarking on marriage or entering into a civil partnership. These allowances include:

  • £5,000 for a child
  • £1,000 for any other individual getting married
  • £2,500 for someone who is a grandchild or great-grandchild

Should you opt to provide gifts to the same recipient, you can combine the wedding gift allowance with any other applicable allowance, with the exception of the small gift allowance.

For instance, within a single tax year, you could present your child with a wedding gift amounting to £5,000, in addition to utilising £3,000 from your annual exemption.

Inheritance Tax Rates and Calculation example

Working out your inheritance tax can be a complex process, but following a step-by-step approach can make it more manageable. Here’s a guide to help you navigate the calculations:

Step 1: Determine the value of the estate

The first step is to calculate the total value of the deceased’s estate. This includes all assets, such as property, investments, cash, and personal possessions.

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Step 2: Identify any deductible expenses

Certain expenses can be deducted from the estate’s value before calculating inheritance tax. These may include funeral expenses, outstanding debts, and mortgage balances. Keep records of all eligible expenses for deduction.

Step 3: Establish the nil-rate band threshold

The nil-rate band is the portion of the estate that is exempt from inheritance tax. For the 2023-2024 tax year, the nil-rate band is £325,000. If the estate’s value falls below this threshold, no inheritance tax is due.

Step 4: Consider the residence nil-rate band (RNRB)

If you are passing on a main residence to direct descendants, such as children or grandchildren, you may be eligible for the residence nil-rate band (RNRB).

an inherited property within the RNRB tax band

In the 2023-2024 tax year, the RNRB is £175,000, potentially increasing the total tax-free allowance to £500,000 for individuals or £1,000,000 for couples (exemptions double with a partner).

Step 5: Calculate the taxable estate value I

If the estate’s value exceeds the available allowances (nil-rate band and RNRB), the excess amount is subject to inheritance tax. Subtract the allowances from the estate’s value to determine the taxable portion.

Step 6: Apply the inheritance tax rate

The current inheritance tax rate in the UK is 40%. Calculate the tax due by multiplying the taxable estate value by 40%.

Step 7: Account for any exemptions or reliefs

Certain exemptions and reliefs may further reduce the inheritance tax liability. For example, if you are transferring assets to a spouse or civil partner, the spouse exemption allows for a tax-free transfer. Other reliefs, such as business property relief or agricultural property relief, may also apply.

Step 8: Consider the impact of gifts

If the deceased made any gifts within seven years of their death, these may be subject to inheritance tax, depending on their value and the time elapsed since the gift was made. Refer to the taper relief rules to calculate the applicable tax rate.

Step 9: Seek professional advice

Inheritance tax calculations can be complex, especially for larger estates or those with intricate asset structures. It’s advisable to seek guidance from a qualified professional, such as aconveyancer, tax advisor or solicitor.

Read about the difference between a conveyancer and solicitor here

This ensures accuracy and compliance with the latest regulations.

Strategies to reduce Inheritance Tax

While inheritance tax is an unavoidable reality for many, there are several strategies that can be employed to minimise its impact. Understanding and utilising these strategies can help preserve more of your hard-earned wealth for your loved ones.

Donating to charity or politcal parties

One effective way to reduce your inheritance tax liability is by donating to registered charities.

donating to charity to avoid IHT

Charitable donations are exempt from inheritance tax, providing a valuable opportunity to support causes you care about while simultaneously reducing your taxable estate’s value.

Data suggests that in the tax year 2020-2021, the value of exempted transfers to qualifying charities amounted to £1.8 billion.

Using trusts

Trusts can be a powerful tool for inheritance tax planning. By transferring assets into a trust, you can potentially remove them from your taxable estate, provided you survive for seven years after making the transfer.

However, it’s essential to note that the rules surrounding trusts can be complex and you will still be taxed on equity within a trust if it has been at least 7 years before you are deceased.

Maximise value before you pay tax

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This is important because estate planning using trusts must be done years in advance if you want to get the most tax benefit and during that time it is a good idea to maximise the value of property or estates as in a trust they are out of your control.

Using life insurance to pay inheritance tax

Life insurance policies can be an effective way to cover potential inheritance tax liabilities.

How does life insurance help pay inheritance tax?

By taking out a policy and arranging for the proceeds to be paid into a trust, the funds can be used to settle any inheritance tax due upon your death. This can help prevent the forced sale of assets, such as property, to cover the tax bill.

Is using life insurance better or worse?

The decision to use life insurance to pay inheritance tax depends on various factors, including the size of your estate and your overall financial situation.

a man who is trying to walk away from death

Life insurance can be advantageous if you have a larger estate and want to ensure that your beneficiaries receive the full value of your assets without having to liquidate them. However, for smaller estates, it may be more cost-effective to pay the inheritance tax directly from the estate’s assets.

Ultimately, the choice between using life insurance or paying inheritance tax directly should be made after careful consideration and consultation with a professional financial advisor.

How to come up with the right plan for your inheritance tax

When determining whether it is worth passing on a home, it is crucial to consider the potential tax implications and the value of the property relative to the available allowances and exemptions.

If the value of the property, combined with the rest of the estate, exceeds the available allowances, inheritance tax may be payable on the excess amount.

Inheritance tax on property planning

However, if the value of the property falls within the allowances, passing it on to direct descendants can be a tax-efficient way to preserve the family’s assets.

It is essential to seek professional advice from a qualified financial advisor or estate planner to assess the specific circumstances and develop an appropriate strategy.

Maximise the value of your estate before death

After you have passed away, there is little that you can do to control the size of an asset or how it performs. This meanst that while you’re here, you should aim to maximise the value of the asset you’re leaving behind – property included.

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Plan in advance

There are areas of the Inheritance Tax laws that restrict you based on time, something no one can change. Gift giving must happen seven years in advance in order for gifts to be completely tax free.

Also equity put into trusts also need a minimum of seven years in a trust before you die before they are exempt from any tax. As a result, it is important you plan ahead and involve family members as soon as you can.

What other taxes and costs do my heirs have to pay on their inheritance?

Inheritance tax is applicable to property, savings, and other assets left behind after debts and funeral expenses have been settled. But what other taxes will be left over to your heirs?

Property tax

Potential Income Tax

Inheritance received may be subject to income tax depending on the nature of the assets inherited.

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For example, if inherited assets generate income, such as rental properties or investments, the heirs may be liable to pay income tax on the earnings generated.

Capital Gains Tax

In some cases, heirs may need to pay capital gains tax if they decide to sell inherited assets that have increased in value since the date of inheritance. The tax is calculated based on the increase in value between the date of inheritance and the date of sale.

Soliciting and conveyancing

Heirs may also incur legal and administrative costs associated with the transfer of inherited assets. These costs include fees for solicitors, conveyancers, and other professionals involved in managing the inheritance process, such as obtaining probate or transferring property ownership.

The information provided in this article is for informational purposes only and should not be construed as professional advice. Please rely on a lawyer for direct advice.

We are not liable for any actions taken based on the content herein and you should always refer to governmental sources and the Inheritance Tax Act to make final decisions. Cozee Properties are not lawyers or solicitors and you should not rely on the information in this article to make a financial decision

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