How to Avoid Inheritance Tax on Property

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How to Avoid Inheritance Tax on Property

Inheritance tax (IHT) in the United Kingdom can be a significant concern for many, particularly when it comes to passing on property—one of the most valuable assets in an individual’s estate. With the current IHT threshold set at £325,000, properties often push estates over this limit, leading to potential tax rates of 40% on amounts exceeding the threshold. This guide explores practical strategies to mitigate or even avoid such hefty tax implications legally.

Understanding Inheritance Tax

Inheritance tax is charged on the estate of a deceased person, which includes all their assets (cash, investments, property, etc.) minus any debts at the time of their death. The standard threshold is £325,000, known as the “nil-rate band.” Anything above this amount is taxed at 40%. However, there are several reliefs and exemptions that can help reduce the IHT liability, particularly with property.

The Residence Nil-Rate Band (RNRB)

In addition to the standard nil-rate band, there is a residence nil-rate band (RNRB), which was introduced in April 2017. This is an additional allowance for passing on a home to direct descendants, including children or grandchildren. For the tax year 2023/24, the RNRB is £175,000, which means that an individual could potentially pass on assets worth up to £500,000 without incurring IHT, or £1 million for a married couple or civil partners when combined with the standard nil-rate band.

Strategies to Avoid Inheritance Tax on Property

Make a Will

Making a will is the first step in any inheritance tax planning. Without a will, your estate is distributed according to the rules of intestacy, which might not be the most tax-efficient for IHT purposes.

Gifting Your Property

One common approach to avoiding IHT is to gift your property to your heirs during your lifetime. However, there are several rules and pitfalls to consider:

  • Seven-Year Rule: If you gift your home but continue to live in it rent-free, this is considered a “gift with reservation of benefit,” and the property might still be included in your estate for IHT purposes unless you survive for seven years after the gift.
  • Pre-Owned Asset Tax (POAT): If you continue to benefit from the property after gifting it (for example, by continuing to live there), you might be subject to POAT unless you pay market rent to the new owners.

Establish a Trust

Placing your property in a trust can be an effective way to manage how your assets are passed on to your heirs while potentially reducing IHT. There are different types of trusts, and they can be complex, so professional advice is essential. Trusts are particularly useful if you want to retain some control over the property, such as who lives in it or the conditions under which it can be sold.

Take Out a Life Insurance Policy

A life insurance policy won’t reduce the amount of IHT due on an estate, but the policy pay-out can be used to cover the tax bill. This is particularly useful to ensure that your heirs do not have to sell the property to pay the IHT. It’s important to write the policy in trust; otherwise, the pay-out will be added to your estate and could itself be subject to IHT.

Spend or Give Away Assets

If you can afford to do so, spending or gifting assets before you die is a straightforward way to reduce your estate’s value. Regular gifts out of your income (not capital) that do not affect your standard of living can be exempt from IHT. Larger gifts will be exempt if you live for at least seven years after making them.

Invest in IHT-Efficient Investments

Certain investments qualify for Business Property Relief (BPR) and can be passed on free from IHT after two years of holding them. These often involve higher risks and should be considered as part of a diversified investment strategy.

Conclusion

Inheritance tax planning requires careful consideration and, often, professional guidance. The strategies outlined here can legally mitigate the potential impact of IHT on your estate, particularly regarding property. Whether it’s through making a will, setting up trusts, or making strategic gifts, the key is to plan ahead to ensure that your assets are distributed according to your wishes in the most tax-efficient manner possible.

This guide has covered several legal avenues to help protect your property from significant inheritance tax liabilities. By taking proactive steps today, you can secure peace of mind for yourself and your loved ones for tomorrow.

Avatar of DLS Solicitors by DLS Solicitors
13th May 2024
Avatar of DLS Solicitors
DLS Solicitors

Our team of professionals are based in Alderley Edge, Cheshire. We offer clear, specialist legal advice in all matters relating to Family Law, Wills, Trusts, Probate, Lasting Power of Attorney and Court of Protection.

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