Inheritance tax: what you need to know when gifting money for a property purchase

Inheritance tax can seem complicated, but it’s important you understand it, especially when making your will. Here’s everything you need to know about inheritance tax.

What is inheritance tax?

Inheritance tax (IHT) is a tax levied on someone’s estate when they have died. Their estate includes all of their property, savings and possessions, and it can also apply to some gifts the person makes before they die.

It’s important to understand that not everyone is required to pay inheritance tax. In fact, less than 5% of people in the UK currently have to pay anything, so the vast majority of people won’t be affected by it.

However, as property prices continue to increase, more and more people are falling into the UK inheritance tax thresholds when they die. 

How does inheritance tax work?

The current inheritance tax threshold is set at £325,00 and is frozen until 2028. This means you do not pay any inheritance tax on the first £325,000 of your estate. So, if the total value of your estate is less than £325,000, there will be no IHT to pay after you die.

However, if you leave your home to a direct descendant - i.e. your children or grandchildren, the tax-free allowance can be boosted up to £500,000. This extra £175,00 allowance, known as the ‘main residence band’, only applies if your property is worth less than £2 million.

Anything left to a spouse or civil partner is also exempt from IHT, which applies no matter the value of your estate. It’s important to note that this only applies if you are married or in a civil partnership, not if you are only cohabiting, even if you have children together.

This also means that your spouse’s IHT allowance will rise by the percentage amount that wasn’t used in your allowance. 

That means a married couple could potentially leave an estate worth up to £1 million to their children (two tax-free allowances worth £650,000 and two main residence allowances worth £350,000). 

How much is inheritance tax?

IHT is charged at 40% on anything above the threshold of £325,000 (or £500,000 if using the main residence band, too). 

For example, if your estate is worth £600,000, you will be charged IHT on £275,000. This means the executors or administrators of your estate will face a tax bill of £110,000 (40% of £275,000).

If you can use the main residence band, you would only be charged IHT on £100,000, resulting in a bill of £40,000 (40% of £100,000). 

Who pays inheritance tax?

It is usually the responsibility of the person dealing with the estate to pay the IHT bill to HMRC. If there is a will, this will be the executor; if there isn’t a will, this will be the administrator of the estate.

IHT is paid from the proceeds of the estate before any money is distributed to the beneficiaries of the will. It is the executor or administrator’s responsibility to calculate how much IHT needs to be paid, and they will be accountable for any mistakes made.

How to calculate the value of an estate

To accurately calculate the value of an estate, you should: 

  • Identify the deceased’s assets, including any savings, investments and properties

  • Identify their debts, including loans, mortgages and credit cards

  • Identify any gifts they made in the seven years before they died

You can then use this information to understand if the estate will owe any tax, i.e., whether the value will likely be over £325,000 (if not left to a spouse or civil partner). 

If it is likely to be over the threshold, you will need to carry out accurate valuations to establish the estate’s value and how much tax you will need to pay.

To help you do this, you can use the inheritance tax calculator.

When do you pay inheritance tax?

It must be paid to HMRC within six months of the person’s death. If the payment is made later than this, HMRC can start charging interest on the amount owed.

It is also possible to pay tax on certain assets in instalments over a period of 10 years; however, this will incur interest. If the asset is sold before the IHT tax bill is paid, all of the remaining instalments and interest must be paid at this point.

If it looks like it may take longer than six months to value the estate, it may be worth attempting to pay at least some of the bill in the first six months. This could prevent any interest from being added to your bill, and HMRC will refund the estate if you have overpaid.

Inheritance tax gifts and exemptions

It is possible to make gifts to family and friends while you’re alive to reduce the value of your estate for IHT purposes.

However, there are specific rules you need to follow to avoid any gifts you give incurring IHT. Here are the gifts you can give to reduce your IHT burden:

  • You can gift up to £3,000 every year without it being added to the value of your estate - this is known as your annual exemption

  • Anything given to charity either in your lifetime or in your will is exempt from IHT - it can also potentially reduce your rate from 40% to 36%

  • You can give as many gifts of up to £250 as you like, provided it’s not to someone who has received the whole of your £3,000 gift allowance

  • Wedding gifts to your children given before the wedding are exempt, provided they are £5,000 or less

Any gift you give becomes exempt from IHT after seven years. That means if you live for more than seven years after giving a gift that would be subject to inheritance tax, it would then not be included in the value of your estate.

Our expert says…

“Inheritance tax could cost your loved ones thousands of pounds after you die, but the reality is that nearly 96% of people won’t have to pay anything.

However, it’s really important to understand the ins and outs of inheritance tax so you know what to expect and can take steps to reduce the burden on your family.”

Inheritance tax FAQs

It is possible to gift your home to your children, and if you do it at least seven years before you die, it won’t count towards your estate when calculating IHT.

You can still live in the house; however, you may need to pay rent to avoid IHT. If you don’t, this will be considered a Gift with Reservation of Benefit (GROB), which is where you have made a gift but retain the full benefit of the property.

The rent you pay must be at the market rate and cannot just be a nominal amount. This means your children will then be liable to pay income tax on the rent you pay them. They may also need to speak to the mortgage lender to check that the mortgage allows them to rent the property out.

You can avoid this by cohabiting in the property with your children. Provided you share responsibility for the household expenses, it will then be treated as an outright gift. 

Gifting your home can be complicated, so it’s worth getting advice from a professional advisor first.

The seven-year rule means that any gifts made within seven years of the donor’s death may be subject to IHT. It also means that any gift given more than seven years before their death won’t be subject to tax. 

Before seven years have passed, a gift is referred to as a ‘potentially exempt transfer’. It’s also worth noting that the inheritance tax rate reduces over time, known as taper relief. Here’s how it works.

  • 0-3 years since gift - 40% tax due

  • 3-4 years since gift - 32% tax due

  • 4-5 years since gift - 24% tax due

  • 5-6 years since gift - 16% tax due

  • 6-7 years since gift - 8% tax due

  • Over 7 years since gift - no tax due

Yes, life insurance can help to cover your inheritance tax liabilities. People often use life insurance policies specifically designed to provide funds to pay for potential inheritance tax bills upon their death. 

These policies are usually written in trust, keeping the proceeds outside the deceased's estate and, therefore, exempt from inheritance tax.

By naming beneficiaries and placing the policy in trust, the payout can be used to cover the inheritance tax bill without adding to the taxable value of the estate.

This approach can help you make sure that there are sufficient funds available to cover any potential IHT bill, especially when dealing with assets like property or business interests.

It is possible to pay inheritance tax in instalments, especially when the estate includes assets that may take time to sell, such as property. 

This arrangement means the executor or administrator of the estate can spread the payments over a period rather than paying the total amount upfront, usually up to 10 years. 

This option is designed to ease the financial burden on the estate, especially when selling assets quickly might be difficult. However, it's important to note that interest is typically charged on the outstanding amount. 

Paying in instalments can be subject to certain conditions, so it’s worth seeking professional advice before choosing this option.

Suppose the estate doesn’t have enough liquid assets, like cash, to cover the inheritance tax bill. In that case, the executor will need to sell assets from the estate, including property, investments, or other valuable possessions. 

The sale proceeds are then used to settle the bill before the remaining assets are distributed to the beneficiaries of the will. It may be possible to arrange to pay the bill in instalments, but this can come with interest charges.

Executors should seek advice from financial professionals and legal advisors to make sure they comply with the relevant tax regulations and the wishes outlined in the deceased's will.

There are no official plans to cut inheritance tax at the time of writing. There has been growing speculation that the UK government are considering scrapping inheritance tax altogether in the Spring 2024 budget, but this has been dismissed as speculation.

The current inheritance tax thresholds of £325,000 are frozen until April 2028.