In the past Inheritance Tax (IHT) was only incurred by the very top tier of society, but property price inflation has seen an increased number of ‘ordinary’ families being hit. So disliked is this tax that the Conservative party pledged to reform it as part of its manifesto ahead of the 2010 general election, and Chancellor Osborne began to realise this promise in his 2015 Budget announcement.
But the changes are far from straightforward – for now, here’s a rundown of the current position and what the changes will mean.
Despite being announced in March 2015, the changes to IHT won’t begin to be introduced until April 2017. The changes will then be stepped across the period 2017-2020.
Inheritance Tax is currently set at 40% of the estate of a single person worth more than £325,000. This doubles to £650,000 for married couples or those in a civil partnership where the assets are transferred to the surviving spouse or partner.
The consequences depend on something known as the 7-year rule. If you move out of your home and live for another 7 years, subject to certain conditions as outlined below, no IHT will be payable. If you die within 7 years of giving away your property, taper relief applies so that your IHT liability is progressively reduced (for more information on taper relief see Section 5 below).
There are, however, strict conditions relating to the sale or transfer of property from one party to another (known in property law as alienation). If, for example, you want to continue to live in the property after transfer of ownership, you need to be able to demonstrate that you:
- Pay rent to the new owner at market value
- Pay your share of the bills
- Live there for at least 7 years.
The treatment is similar. Small gifts (up to £3,000 each year) out of your income can be exempt, as can gifts made between spouses or civil partners. For gifts of more that £325,000, IHT may be payable under the 7-year rule if you die within 7 years. For the purpose of IHT, gifts include:
- Anything with a value, including money, property or possessions
- A loss in value, for example, if you sell your property to a descendant at below market value, the difference will count as a gift.
Taper relief works in conjunction with the 7-year rule and means that progressively less IHT is due based on how many years pass after an asset is transferred. If you are subject to IHT, non-exempt gifts made in the 3 years before you die will be subject to 40% tax. Gifts made between 3 and 7 years before your death are taxed on the following sliding scale, which the government calls taper relief:
Gifts are not counted towards the value of your estate at all once a full 7 years have passed.
The main change introduced by the Chancellor in the 2015 Budget is to allow individuals and married couples or those in a civil partnership the potential to incur a reduced tax liability when passing on their main or family home to a direct descendant, such as a child or grandchild.
The allowance is on top of the £325,000 existing threshold and will increase each year between 2017 and 2020 as follows:
This means that from 2020, the IHT-free allowance (known as the ‘nil-rate band’) for an individual will effectively rise to £500,000 per person. For example, for someone passing on a family home worth £200,000 together with other assets valued at £300,000, no IHT will be payable. Previously, similar assets would have incurred a tax bill of £70,000.
Meanwhile, married couples, or those in a civil partnership, will be able to pass estates of up to £1m to their children or grandchildren without incurring IHT, as long as this includes a family home.
You should keep in mind, however, that the additional allowance is for the main family home - second homes or buy-to-let property are not eligible as part of the main residence allowance and would count as ‘other assets’.
This is a brief guide to some of the main rules on IHT. The actual IHT position in relation to your estate will depend upon your individual circumstances, so if you are in any doubt it makes sense to take professional advice.
Tax treatment depends on individual circumstances and may be subject to change in the future.
This article has been provided to Lloyds Bank by external/third party contributors and contains their views as of November 2016 and should not be relied upon as fact and could be proved wrong. The information and opinions may not be accurate after this date. The views expressed may not reflect the views of Lloyds Bank plc.
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