Gifts and the seven year rule
Making a gift to your family and friends while you are alive is one way in which you can reduce the value of your estate for Inheritance Tax purposes, while your loved ones have use of the cash or asset immediately.
Gifts given to individuals in your lifetime are known as “Potentially Exempt Transfers”, or “PETs”. There’s no Inheritance Tax payable at the time you make the gift, but if you die within 7 years, it will be added to your estate, and Inheritance Tax may be payable.
Gifts made within 3-7 years of death are taxed on a sliding scale, known as “Taper Relief”, which can reduce the Inheritance Tax due from 40% to just 8%.
If there are more than 7 years between the date of the gift and the date of death, it will no longer form part of the estate, and no Inheritance Tax would be due on the gift.
These are completely free of Inheritance Tax, and will never form part of your estate:
• £3,000 of gifts per tax year (6th April – 5th April); if you don’t use up this exemption, you can carry it forward for one year only. You may gift the whole amount to one or more person, with an overall limit of £3,000.
• Wedding or civil ceremony gifts of up to £1,000 per person (increased to £2,500 for a grandchild or great-grandchild, or to £5,000 for a child).
• Normal gifts out of income without limit, though you must be able to maintain your standard of living after making the gifts – HMRC will look for a pattern of giving to satisfy this classification.
• Small gifts of up to £250 per person, as long as you have not used another exemption on the same person.
• Gifts to charities and political parties.
• Gifts to your spouse.
Nil Rate Band
You are entitled to a Nil Rate Band on the value of your estate – currently, £325,000. Estates valued over this amount are subject to Inheritance Tax on the excess. It is possible for some unused Nil Rate Band to be transferred to a surviving spouse or civil partner, therefore a married couple could potentially have up to £650,000 of Nil Rate Band to offset against the value of their estate.
Giving away your home
If you give away your home before you die, perhaps by transferring it to your children, this would also qualify as a PET, however, if you continue to live in your home after giving it away, beware of the “gifts with reservation” rules, which results in the property still forming part of your estate, unless you pay a full market rent to the new owners.
The level of rent charged should be continually reviewed, and it will be subject to income tax on the new property owners.
Residence Nil Rate Band
The government introduced a Residence Nil Rate Band (RNBR) with effect from 6th April 2017, in addition to the standard £325,000.
The new band, currently £125,000, but rising to £175,000 over the next few years, can be used against the value of a property which was the person’s main residence, but only when it is left to their direct descendants – child, grandchild, or other lineal descendant (or spouse of a lineal descendant), including step-children, and adopted/fostered children.
If the house is left to a granddaughter and a nephew, for example, the value of the house is split into the proportions as inherited by these two individuals, so that the RNBR would not be deducted from the value of the nephew’s share.
The person that dies must have owned and live in the property at some time, but the executors can choose which property to use for the RNBR if there is more than one home that qualifies as the main residence. If the person downsized on or after 8 July 2015, the executors may be able to claim a downsizing addition.
There’s a very valuable relief available for assets given away or left as part of the estate – Business Property Relief.
Transfers of businesses or shares in unquoted trading companies qualify for 100% relief – meaning that there will be no Inheritance Tax to pay, regardless of the value.
Transfers of land and buildings or plant and machinery used by a donor in a partnership or a company he controls, qualify for 50% relief, as do shares from a controlling holding (more than 51%) in a quoted trading company. Effectively, only 50% of the value is subject to Inheritance Tax.
By “trading company”, this means that investment companies or property dealing companies will not qualify for Business Property Relief.
Similarly, Agricultural Property Relief may be available on the agricultural value of land, provided it is used for agricultural purposes, at a rate of 50% or 100%.
For both types of relief, the person who dies generally has tohave owned the asset for at least 2 years prior to death.
This is just a brief overview of Inheritance Tax exemptions and reliefs. Every situation is different, but with careful planning, it is possible to arrange your affairs in such a way as to minimise the impact of Inheritance Tax on surviving family members.