Inheritance tax relates to the estate left by a person when they die. This could be the amount of money they have, property they own or any other assets that belong to them. Gifts made during that person’s lifetime may also be affected by inheritance tax. There is generally no inheritance tax on property passed by the deceased to their spouse or civil partner where the property is their main place of residence, i.e. their home.
The executors or personal representatives of the deceased’s estate will be responsible for:
- administering the deceased’s estate
- calculating the amount of inheritance tax to be paid
- paying any inheritance tax due, either from capital held by the estate or by the sale of estate-held assets
only once payment of inheritance tax and any other taxes has been made, distributing the estate to beneficiaries in accordance with the will, or under the laws of intestacy where there is no will in place
The usual schedule for payment of inheritance tax is the last day of the month which is six months after the death of the deceased. Any outstanding amount that remains after that date will incur interest, payable to HMRC, of 3.25%.
Inheritance tax on gifts made less than seven years before death
Gifts made by the deceased may be subject to inheritance tax on property where less than seven years passes between the gift being made and the deceased’s death, and the value of the gift exceeds the annual exemptions. In this situation, inheritance tax is payable by the person who received the gift, but only where the value of the gift is above the nil rate which stands as at February 2019 at £325,000.
Where the gift was made over 3 years prior to death, taper relief may be available. The level of taper relief rises (and the corresponding tax payable decreases) along with the number of years between the gift and death, as follows:
- Less than 3 years – 40% tax due
- 3 to 4 years – 32% tax due
- 4 to 5 years – 24% tax due
- 5 to 6 years – 16% tax due
- 6 to 7 years – 8% tax due
Gifts with reservation
Where an individual gifts their home so that they may avoid care home fees but continues to reside in that property, this is generally known as a gift with reservation. This means that although they have given the property away, they still receive some benefit from that property.
In the case of a gift with reservation, the property is deemed to still be within that person’s estate for the purpose of inheritance tax. The exception to this rule would be where the person making the gift paid market value rent to live there.
Where the gift is only of a share in the property, and the property therefore has joint owners of the donor and the person the gift was made to, the gift with reservation rule may be relaxed as long as both owners share the running costs of the property.
An exception to the gift with reservation rule is where a property is gifted and the donor uses the property for short periods of time only, such as:
- social visits
- short stays up to two weeks in a year in the absence of the new owner
- short stays up to four weeks in a year while the new owner is present
- to convalesce
- to babysit
How to calculate inheritance tax on property
Where the total value of the deceased’s estate and any gifts made by them less than seven years before their death is above the nil rate band, inheritance tax will be chargeable at a rate of 40%.
Where the deceased is survived by their spouse or civil partner, any unused portion of the deceased’s nil rate band may be transferred to the surviving partner’s nil rate band. This means the surviving spouse or partner may potentially have a double nil rate band of £650,000 at the point of their death.
Under a Deed of Variation, beneficiaries of a deceased’s estate, either where there is a will or the where the rules of intestacy apply, may agree to distribution of assets in a manner which reduces the amount of inheritance tax payable. Where a Deed of Variation is instigated, it must be signed by all affected beneficiaries to demonstrate their agreement to the variation.
The Deed of Variation must be completed no later than two years after the death of the deceased and bear a signed statement of the variation.
A Deed of Variation can similarly be used where the deceased has transferred assets into a trust to be distributed to beneficiaries, and must again be completed within two years of the death.
Generally, a lifetime gift will not incur inheritance tax straightaway, but an inheritance tax liability may be triggered if the donor dies less than seven years later.
The exceptions to this rule are transfers to and from trusts, transfers to companies, and transfers made by close companies, which are subject to inheritance tax at a rate of 20% when they are in excess of the nil rate band and made less than seven years before the death of the deceased.
This type of relief makes it possible to pass on agricultural property without incurring inheritance tax, either as a lifetime gift or on death.
Qualifying agricultural property must be located in the UK, Isle of Man, Channel Islands or an EEA country, and used mainly for the purpose of growing crops or rearing animals, for instance, a stud farm, harvestable coppice, or farm cottage.
The following are not eligible for agricultural relief:
- farm machinery and equipment
- harvested crops
- derelict buildings
- property that has already been sold
Any farm buildings must be of an appropriate size, nature and condition for use in a farming context.
Relief is calculated on the agricultural value of any property, that is, on the basis of the property’s use in an agricultural context. The value of any existing mortgage will reduce the value of the property eligible for relief.
A farm cottage or farmhouse will only be eligible for agricultural relief when occupied by persons who work in a farming role, are retired from farming work, or are the spouse or civil partner of a deceased farm worker. Any occupant must be a tenant in connection with their present or past employment, or a protected tenant who has statutory rights.
Where the property was occupied and controlled by the deceased owner, their spouse or civil partner, or a company, it must have been used for agricultural purposes for at least two years immediately before the death of the deceased and the property’s subsequent transfer. Where the property was occupied by someone else, the period of agricultural use extends to seven years.
Agricultural relief of 100% is only available where:
- the deceased owner farmed the land themselves, or
- the land was used by another person via a short term grazing licence, or
- the property was rented out on or since 1 September 1995, or
- the deceased owned the property since 10 March 1981 and rented it out, the property qualified for relief under
- the old estate duty rules, and the owner had no right to vacant possession between that date and their death.
Unless any of the above apply, the rate of agricultural relief is 50%.
Residence nil rate band
Where property is passed to a direct descendant, it may be possible to apply the residence nil rate band. A direct descendant could be a child, grandchild, stepchild, adopted child, foster child, ward, or the spouse, civil partner, widow, or widower of a child or grandchild.
The residence nil rate band was introduced in April 2017 as an additional relief which raises the inheritance tax threshold under certain circumstances.
As at February 2019, the residence nil rate band is £125,000. In April 2019, this will rise to £150,000.
Properties that qualify for residence nil rate band are required to have been the main residence of the deceased at some point during the period of ownership. Where the property was owned but never occupied by the owner, it does not qualify for the residence nil rate band.
Where the deceased had numerous residences, the residence nil rate band may only be applied to one of them.
Where the value of the entire estate, including property, amounts to more than £2 million, there is a reduction to the residence nil rate band of £1 for each £2 over £2 million.
Where the deceased leaves their estate to their spouse or civil partner, the spouse exemption removes any inheritance tax liability, as long as the surviving spouse or civil partner has UK domicile status. Any portion of the deceased’s nil rate band that is unused may be transferred to the surviving partner’s nil rate band.
Residence nil rate band downsizing provisions
The process of downsizing, buying a smaller home, is becoming more and more popular for older individuals as their need for space becomes less, perhaps when sons and daughters move out to buy their own homes, or to reduce costs. The downsizing provisions take this into account by restoring the partial or full benefit of any lost residence nil rate band.
The downsizing provisions apply when an individual dies after 5 April 2017, having sold their home or downsized to a property of less value on 8 July 2015 or after.
Where the downsized property and other estate-held assets are passed to children or grandchildren of the deceased, an additional nil rate band will generally be available at whichever is the lower value of the residence nil rate band or the value of other inherited assets.
Where downsizing did not result in the purchase of a new home, the downsizing provisions may still apply where estate-held assets in lieu of the property are left to children or grandchildren.
Payment of inheritance tax on property in instalments
Payment of inheritance tax in instalments may be possible over a period of up to 10 years where the executors or personal representatives of the deceased request to do so on the IHT400 inheritance tax account form.
The initial 10% instalment is payable six months after the end of the month of the death. Following instalments are paid on the anniversary of the first payment until the account is cleared. Any outstanding amount will incur an interest charge of 3.25%.
Should the inherited property be sold, the inheritance tax liability, including any interest incurred, must be paid off at that point.