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How Inheritance Tax Works: Exemptions, Rules, and Allowances
- aafra9
- 2 days ago
- 6 min read
Updated: 22 hours ago
Overview on Inheritance Tax
Overview on Inheritance Tax
Inheritance Tax (IHT) is charged on the estate of someone who has passed away. An estate typically includes property, money, and possessions.
In most cases, no Inheritance Tax is due if either:
The estate’s total value is below the £325,000 threshold.
Anything above the threshold is left to a spouse, civil partner, registered charity, or a community amateur sports club.
Even if the estate’s value is under the threshold, it may still need to be reported.
If you leave your home to your children or grandchildren (including adopted, foster, or stepchildren), the threshold can increase to £500,000.
Married couples and civil partners can combine unused thresholds. This means if one partner’s estate is below the threshold, the unused portion can be transferred to the surviving partner, potentially allowing estates worth up to £1 million to be tax-free.
What is Inheritance Tax Rates ?
The standard rate is 40%, applied only to the portion of the estate above the threshold.
Example:
If your estate is valued at £500,000 and your tax-free threshold is £325,000, IHT will be charged at 40% on the remaining £175,000.
If you leave 10% or more of your net estate to charity, the rate may be reduced to 36%.
Reliefs and Exemptions
Some gifts given during your lifetime may still be subject to IHT depending on when they were made. Taper relief may reduce the rate on certain gifts.
Business Relief and Agricultural Relief can reduce or eliminate IHT on qualifying assets such as farms, woodland, or certain business property.
Who Pays the Inheritance Tax ?
Inheritance Tax is paid from the estate’s funds by the executor (if there’s a will) or administrator. Beneficiaries usually don’t pay tax on what they inherit, though they may owe other taxes (e.g., rental income tax if they inherit property).
However, if gifts above £325,000 are made and the giver dies within seven years, IHT may apply.
2. What are the rules for passing a home to a spouse or partner or children or grandchildren ?
You can transfer your home to a spouse or civil partner without paying Inheritance Tax.
If the property is left to someone else, it is included in the estate’s value.
The tax-free threshold can rise to £500,000 if:
The property is passed to children or grandchildren.
The estate is worth less than £2 million.
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Giving Away a Home Before Death
If you transfer ownership of your home and move out, no IHT is due if you live for at least 7 years afterwards.
If you continue to live there, you must:
Pay market-rate rent to the new owner.
Contribute to household expenses.
Stay for at least 7 years.
Otherwise, the gift is treated as a “gift with reservation”, meaning it remains part of your estate for IHT purposes.
You don’t need to pay rent if:
You transfer only part of the property.
The new owner also lives in the property.
If You Die Within 7 Years
If you die within 7 years of giving away a property (or part of it), it is treated as a gift and may be taxed under the 7-year rule.
Note: Gifts with reservation are always counted as part of your estate regardless of the 7-year rule.
3. What are the rules for giving gifts under Inheritance Tax?
What Counts as a Gift ?
A gift can include:
Cash
Household or personal items (e.g., furniture, antiques, jewellery)
Property or land
Listed stocks and shares
Recently acquired unlisted shares (less than 2 years before death)
If something is sold below its market value (e.g., selling a house to a child at a discount), the difference counts as a gift.
Exempt Gifts
Gifts between spouses/civil partners (if both live permanently in the UK).
Donations to charities or political parties.
Allowances for Tax-Free Gifts
Annual exemption: You can give away up to £3,000 each tax year. Unused allowance can roll over for 1 year.
Small gifts: Unlimited gifts up to £250 per person, as long as no other exemption is used for the same recipient.
Wedding gifts: Up to £5,000 for a child, £2,500 for a grandchild, and £1,000 for others.
Regular payments: Ongoing financial support (e.g., for children or elderly relatives) is exempt if it comes from surplus income.
How does the 7-year rule affect Inheritance Tax?
Gifts are tax-free if the giver survives 7 years after giving them (unless part of a trust).
If death occurs within 7 years, taper relief applies:
Years between gift & death | Tax rate |
3 to 4 years | 32% |
4 to 5 years | 24% |
5 to 6 years | 16% |
6 to 7 years | 8% |
7+ years | 0% |
Gifts with Reservation
If you give something away but continue to use or benefit from it (e.g., gifting your home but still living there), it is treated as part of your estate.
Record Keeping
Keep records of gifts, including:
What was given and to whom.
The value.
The date of transfer.
How Tax on Gifts is Paid ?
The estate usually pays any IHT on gifts. If total gifts in the 7 years before death exceed £325,000, recipients may be liable for tax.
Example:
If someone gave gifts of £50,000 (9 years ago), £325,000 (4 years ago), and £100,000 (3 years ago), only the last gift may be taxable.
4. What happens to Inheritance tax If You Die While Living Abroad
If you’re considered non-UK domiciled, IHT generally applies only to UK-based assets (e.g., UK property, UK bank accounts).
You are treated as non-UK domiciled if you lived in the UK for fewer than 10 years in the last 20 years.
Excluded assets include:
Foreign currency accounts in UK banks or Post Offices.
Overseas pensions.
Investments in authorised unit trusts and open-ended investment companies.
Different rules may apply for assets in trusts, government gilts, or if you are part of visiting armed forces.
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Deaths Before 5 April 2025
You may be treated as UK domiciled if:
Your permanent home was in the UK.
You lived in the UK for at least 15 of the last 20 years.
Your permanent home was in the UK at any point in the 3 years before death.
Double Taxation Treaties
If both the UK and another country charge IHT on the same asset, your executor may be able to reclaim some tax through a double-taxation treaty.
FAQs
1. Do I need to pay Inheritance Tax if I inherit from my parents?
No, beneficiaries do not usually pay Inheritance Tax themselves. Instead, the tax is paid from the deceased person’s estate before assets are distributed. However, if you inherit a property or money that generates income (such as rent or interest), you may need to pay Income Tax on that income later.
2. Can life insurance help reduce Inheritance Tax?
Yes. If a life insurance policy is written ‘in trust,’ the payout goes directly to your beneficiaries rather than forming part of your estate. This keeps the payout outside Inheritance Tax calculations, reducing the overall tax bill.
3. Is Inheritance Tax the same across the UK?
Mostly yes, but there are slight variations. Scotland and Wales follow UK Inheritance Tax rules set by HMRC, but additional rules may apply for property laws, probate processes, or exemptions. It’s best to check the specific guidance for your region.
4. Can Inheritance Tax be paid in instalments?
Yes. HMRC allows Inheritance Tax to be paid in instalments (usually over 10 years) if the estate includes assets such as property, shares, or a business that cannot easily be sold immediately. Interest may still be charged on unpaid amounts.
5. What happens if Inheritance Tax is not paid on time?
If Inheritance Tax is not paid within six months of the person’s death, HMRC will begin charging interest on the outstanding amount. Executors may also face penalties for delays, so it’s important to settle the bill promptly.
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