How to Avoid Inheritance Tax on Property

How to Avoid Inheritance Tax on Property

As property prices have increased, so too has the potential inheritance tax bill to pay when a property is passed from one generation to another.  A question being asked more and more is ‘can i give away my home to my children to avoid inheritance tax?’.  We’ve spoken to our tax advisors to find out the answer to this question.

How would a person work out how much Inheritance Tax is due on their home?

Inheritance tax is currently 40% of the value of your entire estate although everyone is entitled to an amount up to a certain threshold (currently £325,000) where they can pass their home and possessions without paying any inheritance tax.

When working out how much inheritance tax may be due on your home remember to include all your possessions such as property, cash, non state pensions and jewellery but deduct any money you owe such as loans, mortgages and credit card balances.  Any amount over the threshold of £325,000, will be subject to inheritance tax.

There are some exemptions available if you leave money to your spouse, civil partner or to charity. Find out more here.

What is The 7 year rule and how may it help?

You are entitled to give away gifts throughout your life as you wish.  However some of these gifts will count towards the value of your estate when working out how much inheritance tax to pay to HMRC.

Small gifts are exempt and these are defined by HMRC as including christmas presents, birthday presents, charitable donations, assistance for an elderly relative  and wedding or civil ceremony gifts of up to £1,000 per person (£2,500 for a grandchild or great-grandchild, £5,000 for a child).

In addition we all receive an annual £3,000 exemption for other gifts we may give away without this affecting how your estate is valued for inheritance tax purposes.

Obviously these won’t be sufficient when you are considering what happens to your family home, so this is where the 7 year tax rule may become useful.  Under this rule gifts made more than 7 years before you pass away do not count as part of your estate.  So if a parent, for example, chooses to ‘gift’ their family home onto their children, it won’t be included in the value of the parents estate for inheritance tax purposes if the parent lives for more than 7 years after making the gift.

What happens if i die within 7 years?

Inheritance tax will become due however the tax rate applicable will be reduced (‘tapered’) depending on the number of years since the gift was made as follows:

Less than 3 years 40%

3 – 4 years 32%

4 – 5 years 24%

5 – 6 years 16%

6 – 7 years 8%

7 or more 0%

Will I need to move out of my house?

Not necessarily.  However to take advantage of the seven year rule and remain living in your house you must:

  • pay rent to the new owner at the market rental rate;
  • pay your share of the bills;
  • Live there for at least 7 years.

You won’t need to pay rent if you only give away part of the property or the new owner(s) of the property live with you.

If these conditions are not met, your home could find itself being included within the estate value for inheritance tax purposes.

What about Capital Gains Tax?

If you are gifting your own home then no Capital Gains Tax is due on the transfer, as it is your principal private residence.  However if you are trying to give a second property, then capital gains tax may arise as the property is in effect being sold.  We would always advise speaking to a tax advisor before transferring a property, whether it is your family home or an investment property to make sure you are fully aware of the tax implications.

This all sounds great but is there anything else people should be aware of when gifting their home?

It’s so important to realise that on paper you will no longer own your home and lose all say around what happens to it.  Unfortunately any individuals situation can change and this includes your own childrens.  A child could find themselves in the tricky situation of facing bankruptcy putting your home at risk.  Or perhaps through no fault of their own may need to divorce their partner at which point your home could become a part of divorce discussions.

Whilst your only intention may be to take care of the future generations whilst reducing a tax on everything you have worked so hard to keep, you still need to make sure you protect yourself and not leave yourself in a position where you can’t continue to enjoy your home.

If you are considering your options to avoid or reduce inheritance tax on your estate, we recommend always speaking to a Tax Advisor who will make sure you take the right steps to finding the right tax plan for your situation.

Related: How Does Inheritance Tax Work?