Inheritance tax is a tax on the money, property and other assets (known collectively as the “estate”) left by an individual who has died. It may also be payable on certain gifts made during a person’s lifetime. You do not, however, usually have to pay inheritance tax on property that you receive from a deceased’s estate.
Any inheritance tax is paid out of the deceased’s estate by the executors or personal representatives before the estate is distributed to the beneficiaries in accordance with the deceased’s will, or, if there was no will, under the laws of intestacy.
The executors or personal representatives administer the estate and are responsible for ascertaining the amount of any inheritance tax that is due. They also ensure that any inheritance tax due is paid from cash held within the estate, or from the realisation of assets if appropriate.
Inheritance tax is usually paid on the last day of the month which falls six months after the month of the deceased’s death. Any amount unpaid attracts an interest charge from HMRC, currently at 2.75%.
Inheritance tax on property on gifts made by the deceased less than seven years before his or her death
Gifts by the deceased which exceed the annual and other gift exemptions in the seven years preceding death are treated as part of the deceased’s estate on death for inheritance tax purposes. Any tax due on the gift is payable by the donee. If the total value of the gifts does not exceed the nil rate band, no tax is payable on the gift. Tax is only payable on the value of the gifts that exceeds the nil rate band.
If the gift took place more than 3 calendar years before the date of death, a relief known as “taper relief” will be due. The amount of taper relief increases with the number of calendar years between the date of the gift and the date of death:
|Years between gift and death||Tax due|
|Less than 3||40%|
|3 to 4||32%|
|4 to 5||24%|
|5 to 6||16%|
|6 to 7||8%|
Inheritance tax on property: gifts with reservation
It is not uncommon for individuals to give away their home, often with the intention of avoiding care home fees, but continue to live in it.
This is known as a “gift with reservation” and the rules on gifts with reservation provide that in such circumstances, the property is treated as remaining in the individual’s estate for inheritance tax purposes. The gift with reservation rules will not apply if the donor pays the donee a full market rent for the use of the property throughout their occupation. There is a relaxation of the gift with reservation rules where someone makes a gift of a share in a property, which is then occupied by all the joint owners including the donor, provided that each joint owner then bears his or her share of the property’s running costs.
The gift with reservation rules will not apply when the donor’s use of the gifted property is relatively trivial. Some examples of such use given in HMRC guidance are social visits, babysitting, and short stays for periods of up to two weeks a year (four if the donee is present at the time) or for periods of convalesce or while the donor’s house is being redecorated.
How is inheritance tax on property calculated on death?
Inheritance tax is payable if the taxable value of the estate plus any gifts made by the deceased in the seven years prior to death exceeds the nil rate band (currently £325,000). The rate of inheritance tax on death is 40%.
When one spouse or civil partner dies before the other and any part of their nil rate band is unused at the time of the first death the amount of any unused nil rate band may be added to the nil rate band of the surviving spouse or civil partner.
In certain circumstances, beneficiaries under a will or intestacy may agree to receive assets in a way which is more desirable, frequently to achieve a better result for inheritance tax than would have been possible had the terms of the will or rules of intestacy been observed. This is known as a Deed of Variation. When a Deed of Variation is made, it is possible to make a form of election for inheritance tax purposes so that the terms of the Deed of Variation are substituted for the terms of the will or intestacy.
The Deed of Variation must be made within two years of the death and must contain a statement to the effect that the relevant legislation applies.
A similar relief is available where assets are left in trust by the deceased and within two years of the death, the trust assets are instead distributed directly to beneficiaries.
Inheritance tax on property: chargeable lifetime transfers
Most lifetime gifts are not immediately chargeable to inheritance tax, although they may become chargeable if the donor dies within seven years of making the gift.
However, there are two classes of transfer that attract inheritance tax if they, together with any similar transfers made within the preceding seven years, exceed the nil rate band at the time the transfer is made.
These transfers are subject to tax at 20% to the extent that they exceed the nil rate band. The two categories of gifts concerned are transfers to and from most forms of trust and transfers to and from close companies.
Inheritance tax on property: agricultural Relief
There is a specific relief relating to certain agricultural property that is situated in the UK, Channel Islands, Isle of Man and the European Economic Area. Qualifying agricultural property can be passed free of inheritance tax, either as a lifetime gift or on death.
Agricultural property qualifies for the relief if it is land or pasture that is used to grow crops or to rear animals intensively. The following also qualify for relief:
- growing crops
- stud farms
- trees planted and harvested at least every 10 years (known as short-rotation coppicing)
- land not currently being farmed under the Habitat Scheme
- land not currently being farmed under a crop rotation scheme
- the value of milk quota associated with land that qualifies for relief
- some agricultural shares and securities
- farm buildings, farm cottages and farmhouses
The following items are excluded from agricultural relief:
- farm equipment and machinery
- derelict buildings
- harvested crops
- property subject to a binding contract for sale
In the case of farm buildings, cottages and farmhouses, these must be of a nature and size appropriate to the farming activity.
Agricultural relief is only given on the value of the property on the assumption that it can only be used for agricultural purposes; this is known as the ‘agricultural value’. To the extent that the market value of a farm cottage or farmhouse exceeds the agricultural value, there is no relief for the excess.
In order to qualify for the relief, a farm cottage or farmhouse must be occupied by someone employed in farming, a retired farm employee or the spouse or civil partner of a deceased farm employee. They must occupy the property either as a tenant under a lease granted as part of their former employment contract or as a protected tenant with statutory rights.
In order to qualify for agricultural relief, the property must broadly have been owned and occupied for agricultural purposes immediately before the relevant inheritance tax event for two years if occupied by its owner, a company controlled by them, or their spouse or civil partner and seven years if occupied by any other person.
The amount of any mortgage or other secured debts on the property reduces the amount of the value that qualifies for agricultural relief.
The rate of agricultural relief is 100% if either:
- the person who owned the land farmed it in hand
- it was let to a third party on a short-term grazing licence
- it was let on a tenancy that began on or after 1 September 1995.
- the property had been owned since before 10 March 1981 and rented out before then if it would then have qualified for relief under the old estate duty rules and the person who owned it had no possible right to vacant possession between that date and the date of the relevant IHT event.
The rate of 50% in all other cases.
Inheritance tax on property: the residence nil rate band
From 6 April 2017, the first £100,000 of a home’s value is also exempt from inheritance tax as long as it passes to a “direct descendant” of the deceased. This additional relief is known as the “residence nil rate band”.
The amount of the relief will rise by £25,000 each tax year so that by 2020/21 it will be £175,000. The standard nil rate band will then be applied to the remainder of the estate.
In order to qualify for this relief, the property in question must have been the residence of the deceased at some time, so other properties, e.g. buy-to-let properties, will not qualify for the relief.
If the deceased had more than one residence, only one of the deceased’s residence will qualify for the relief.
As indicated above, the relief is only available where the deceased leaves his or her home to direct descendants. Direct descendants include children, grandchildren, step-children, adopted children, foster children and their spouses.
To the extent that estate as a whole exceeds £2million (not just the property itself), the residence nil rate band is reduced by £1 for every £2 of the excess.
If a married person or someone in a civil partnership dies and leaves their estate to their spouse or partner, there is no inheritance tax as the spouse exemption applies (provided that the surviving spouse is domiciled in the UK). However, any unused residence nil rate band can be effectively passed on to the surviving spouse or partner and can be applied to their estate on their death. This apples on the death of a surviving spouse or partner after 5 April 2017, irrespective of the date of death of the first spouse or partner to die.
Inheritance tax on property: the residence nil rate band downsizing provisions
It is becoming increasingly common for the elderly to “downsize” (i.e. to purchase a smaller and cheaper property to live in) either for practical domestic reasons or to fund care. The legislation caters for such situations.
If a person dies after 5 April 2017 and has either disposed of their only residence on or after 8 July 2015 or downsized to a lower value property since that date, the downsizing provisions may apply.
The aim of the downsizing provisions is to restore some or all of the benefit of the lost residence nil rate band. The downsizing provisions provide that, as long as both the downsized residence (if any) and other assets in the estate are inherited by children or grandchildren of the deceased, the estate will qualify for an additional amount of nil rate band. This will be broadly equal to the lower of the amount of the residence nil-rate band and the value of the other assets inherited by the children or grandchildren.
The precise rules differ depending on the facts of the situation. If the deceased sold his or her home and bought a new residence, the new residence must be left to children or grandchildren in addition to the other assets representing the funds realised as a consequence of the downsize.
If, however, the deceased disposed of his or her home but did not acquire a new residence, it is necessary only to leave other assets representing the funds realised as a consequence of the downsize to his or her children or grandchildren to qualify for the additional nil rate band.
Inheritance tax on property: payment in instalments
It may be possible to pay inheritance tax in instalments on certain assets, including property, in equal annual instalments over up to 10 years. This will be especially helpful if you inherit a property that you wish to live in, but it applies equally to other properties.
The executors or personal representatives will usually make an election on the inheritance tax account (form IHT400) to pay in instalments. The first 10% instalment is due and payable six months after the end of the month when the death occurred and subsequent instalments are payable annually on the same date thereafter. Subsequent instalment payments will include an interest charge on the amount of inheritance tax outstanding at the date the instalment falls due. The current rate of interest charged on outstanding inheritance tax is 2.75%.
The full amount of inheritance tax and any outstanding interest must be paid when the asset or property in respect of which the instalments option has been elected is sold. The full amount of any tax and interest may be paid off at any time.
Enterprise Tax Consultants can advise on inheritance tax on property
If you are unsure as to your tax position in relation to inheritance tax, we can assist. The services we offer include:
- Advice on inheritance tax planning
- Advice in relation to your UK income and capital gains exposure
- Advice on asset protection strategies
- Advice and assistance in relation to the disposal of UK residential properties
Contact us for a no-obligation initial conversation with an experienced tax adviser.