What are the Rules for Inheritance Tax on Properties?

Inheritance tax can cost loved one’s hundreds of thousands when you die, yet it is possible to legally avoid huge amounts of it – or potentially pay none at all.

The rules around inheritance tax can be hard to understand at first glance, however, it is important to get your head around it.

Today’s guide will walk you through all the things you need to know about inheritance tax.

How much is inheritance tax?

Inheritance tax is a tax on the ‘estate’ of someone who has passed away.

How much you pay will depend on the value of the deceased’s estate – which is worked out based on their assets (cash in the bank, investments, property or business, vehicles, pay-outs from life insurance policies), minus any debts.

More importantly, there is normally no tax to pay if:

  • The value of the estate is below £325,000 or
  • You leave everything over £325,000 to your spouse, civil partner, a charity, or a community amateur sports club.

If neither of the above applies to your circumstances, your estate will be taxed at 40% on anything above the £325,000 threshold once you die (or 36% if you leave at least 10% of the value after any deductions to a charity in your will).

On the other hand, this £325,000 tax-free threshold could be even higher depending on your circumstances – in some cases, it can be as high as £500,000 or even £1 million. More will be explained throughout this article.

Why do we have to pay inheritance tax?

The politics of inheritance tax is pretty controversial. The idea is that without it you perpetrate inherited wealth, so the children of the rich will stay rich. Inheritance tax redistributes income so some of the money goes to the state to be distributed for the benefit of all.

The argument against it is that when money is earned, you pay tax at the time, so to pay tax on it again is not fair.

After years of rocketing property prices, many more people have been caught by the inheritance tax threshold, raising it higher up on the agenda. However, whatever your views are politically, inheritance tax is a financial fact, meaning it makes sense to know how it can affect you and whether you can soften the blow.

What happens if I inherit my parents’ home?

In the current tax year, 2022-2023, no inheritance tax is charged on the first £325,000 of an estate, anything more than that will be charged 40%.

However, what is charged will be less if you leave behind your home to your direct descendants, such as children or grandchildren. This is because you will then have two tax-free allowances:

  • £325,000 – this is the basic inheritance tax allowance, which still applies.
  • £175,000 – since 2015, you can also take advantage of something called the ‘residence nil-rate band’, commonly known as the ‘main residence’ band. This is an additional allowance you will receive on top of the existing £325,000 inheritance tax allowance if you pass on a main residence to your children or grandchildren.

This means that inheritance tax might not be due on the first £500,000 of your estate (£325,000 + £175,000), depending on who your leave your property to. However:

  • The £175,000 main residence allowance only applies if your estate is worth less than £2 million.
  • On estates worth £2 million or more, the main residence allowance will decrease by £1 for every £2 above £2 million that the deceased’s estate is worth.

Let us put this into an example for you…

Let’s say you have got an estate that is worth £525,000. You have decided to leave your home to your children.

This means no inheritance tax will be charged on the first £500,000 (£325,000 basic allowance + £175,000 main residence allowance).

There will be a 40% charge on the remaining £25,000, giving a total of £10,000 in tax (presuming you are not leaving anything to charity).

If you were not leaving your home to your direct descendants, you would pay nothing on the first £325,000 of your estate, and 40% on the remaining £200,000, meaning you would pay a total of £80,000 to pay in inheritance tax.

Are the rules different if I am married?

There are special rules for those who are married or in a civil partnership – they state:

  • When you pass away, assets are left to your spouse or registered civil partner, provided they are living in the UK, are exempt from inheritance tax.
  • On top of this, your partner’s inheritance tax allowance rises by the percentage of your allowance that you did not use, meaning together a couple can currently leave £1 million tax-free (2 x £325,000 tax-free allowances + 2 x £175,000 main residence allowances).

This can sound very complicated, so here is an example to help you out…

Mr and Mrs Jones have assets worth £1 million between them. Mr Jones dies first in 2022/23 – leaving everything to his wife Mrs Jones. So, his £325,000 tax-free allowance is passed on, as well as his £175,000 main residence allowance. In total, this means that Mrs Jones may have up to £1 million tax-free allowance: her allowance, plus her inherited allowance from her deceased husband.

You do not need to do anything to activate this – the executors of your will just need to send certain documents to HM Revenue & Customs (HMRC) after your death – see HMRC’s guidelines here for more information.

Did this article help? At Boxall Brown & Jones, we want to help ensure your property experience goes as smoothly as possible. No matter what your circumstances are, our home team will ensure you are 100% satisfied with the service you have received.

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