WellTax Blog

Inheritance and Taxes: How Inheritance Tax Works in the UK and What Happens When You Donate a Property

May 15, 2023

In the UK, inheritance tax (IHT) applies to a person’s assets and property at the time of their death. However, IHT can also be a concern for those who are still alive, especially those with high-value assets and property.

It’s important to note that the inheritance tax applies to the donor whether the assets are transferred after the donor’s death or during their lifetime. If transferred during the donor’s lifetime to a trust (CLT), the tax is immediately payable, while if the assets pass to another individual during the donor’s lifetime (PET – Potentially Exempt Transfer), the transfer is initially treated as exempt and will remain so if the donor survives for at least 7 years. Otherwise, if the donor dies within 7 years, it will be taxed as indicated above.

One of the most common ways to limit the impact of IHT is to donate a property to a family member or another loved one. However, it’s important to consider that IHT can also be applied to donations. In general, IHT is applied to properties or assets worth more than £325,000 (also called the Nil-rate band – NRB), but this limit may vary from 2028 onwards.

The NRB of £325k can be used on all assets both during life and on death, and it’s important to remember that during life, you can use the NRB every 7 years (so every seven years you can transfer an asset to a trust without paying IHT). There is then an additional threshold from £175k to £325k of Nil-rate band available only on the death transfer of a home to a direct descendant (children and/or grandchildren). The relief reduces if the property exceeds £2m and is cancelled if it exceeds £2.35m. The unused part of both reliefs can be transferred to the spouse (or civil partner). Also, if the tax-free allowance of £325,000 is not used by the first spouse (or only partially used), it can be transferred to the surviving spouse. This means that after the death of both spouses, the heir can enjoy a tax-free allowance of £650,000.

If the cumulative value of the property and assets exceeds this threshold, inheritance tax may be applied at a maximum rate of 40%. It’s important to note that transfers to spouses are exempt both during life and on death. Additionally, there are a series of small exempt transfers that add up to the annual exemption of £3k.

However, if the donor dies within seven years of the date of the donation, IHT may be applied based on the following rates:

Less than 3 years: 40%

3 to 4 years: 32%

4 to 5 years: 24%

5 to 6 years: 16%

6 to 7 years: 8%

More than 7 years: 0%

Furthermore, IHT can also be applied to non-UK resident donors, but only if the donor transfers property located in the UK. Finally, it’s important to remember that some property donations may be subject to both CGT (Capital Gains Tax) and IHT. Therefore, it’s always advisable to consult a tax professional to understand the tax implications and decide when it’s best to transfer an asset.

Michele Ammirati

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