What is inheritance tax?

While only a small number of estates are large enough to incur inheritance tax, it’s still important to take it into account when making a will. Inheritance tax is paid when you leave assets worth above a certain amount or above to your loved ones after you pass away. It’s an important factor to consider when making your will, to make sure your wealth is passed on to your family and friends.

In this article we explain:

What is inheritance tax and how does it work?

When you die, the government takes inheritance tax from your estate, which is made up of your property, savings and possessions. The amount due is calculated on the total value of your assets, including investments, shares, cars and pay-outs from life insurance policies, once any debts and liabilities have been deducted.

What is the nil-rate band (NRB)?

The nil-rate-band (NRB), which is also known as the inheritance tax threshold (IHT), is the limit to which you pay no tax. For the current tax year, 2023/24, the basic threshold that the government has set is £325,000. This will stay fixed until 2028.

There’s an extra allowance if you pass your home to your children (including adopted, foster, or stepchildren) or grandchildren, which is frozen at £175,000 until 2028. This can increase the threshold up to £500,000 meaning you can potentially shield a larger portion of your estate from inheritance tax, and is known as the residence nil-rate band.

Inheritance tax rates

So, what is the inheritance tax rate? The standard inheritance tax rate is 40% – and it’s only charged on the part of your estate that’s above the £325,000 threshold (known as the inheritance tax threshold/nil-rate band). Which means you don't have to pay any tax on estates valued at less than £325,000.

For example, if your total assets are worth £500,000, the total inheritance tax paid would be £70,000. This is calculated by: 

1. Determining the total estate value: £500,000 

2. Identifying the tax-free threshold: £325,000 

3. Calculating the taxable amount: £500,000 - £325,000 = £175,000 

4. Applying the tax rate (40%): 40% of £175,000 is £70,000 

So, for an estate worth £500,000, you would pay £70,000 in inheritance tax. 

Who pays inheritance tax?

The executor of the will, who is the person who deals with the estate, needs to arrange the payment of inheritance tax to HMRC during the probate process, six months after the person has passed away. However, if there isn’t a legal will, then the administrator of the estate will be responsible for any inheritance tax payments.

Do spouses pay inheritance tax?

There’s nothing to pay if you leave everything over the threshold to your spouse or civil partner, while you can also leave your assets to organisations such as charities and political parties without having to pay any inheritance tax.

Why do we pay inheritance tax on property?

Some people think inheritance tax is unfair, and it’s been voted as the UK’s least popular tax. They argue that they’re taxed in the form of stamp duty, and then their loved ones need to pay again when they die. The issue of direct descendants being the only ones to benefit from residence relief is highly contentious, and property prices have risen considerably since the £325,000 nil rate band was put in place.

However, those in favour of inheritance tax – including the Treasury, which counts it as a huge source of income – argue that it’s necessary. The tax is said to redistribute wealth, rather than perpetuating inherited wealth by the children of the rich receiving the entire family fortune. It can then be spent on public services which benefit the many rather than the few.

What happens when you inherit a house in the UK?

Inheriting a house in the UK involves several key steps, however, don’t worry as immediate action is usually not required. Here's an overview of what to expect:

1. Probate process: Initially, you can't do much with the property until the probate process is complete. Probate is essential for settling the deceased’s debts and organising their affairs.

2. Executor's role: The executor named in the will takes responsibility for managing the probate process. They will handle tasks like paying off any debts and distributing the assets as specified in the will.

3. Tax considerations: Inheritance tax may apply depending on the value of the estate. It's crucial to understand the tax implications and consult with a tax advisor to ensure compliance.

4. Maintenance and upkeep: During the probate process, maintaining the property is essential. This includes regular maintenance and ensuring that utilities are paid.

5. Decision making: Once probate is granted, you can decide what to do with the property.

What are the types of taxes on an inherited property?

When you inherit a property, several types of taxes may come into play. Understanding these will help you manage any financial obligations effectively.

Inheritance tax:

Capital Gains Tax (CGT):

Income tax:

What are the differences between inheritance tax and capital gains tax?

Inheritance tax and capital gains tax are two different types of taxes in the UK, each applying in distinct circumstances. The key differences are:

Do you pay stamp duty on inherited property?

No, you do not need to pay stamp duty on a property you inherit. Stamp duty is typically only applicable when you purchase a property.

How to reduce inheritance tax on your parents' house

If your parents pass on their main residence to you, you can benefit from the basic tax-free allowance of £325,000, and the residence nil-band rate, which is an additional £175,000, meaning any inheritance tax may not be due on the first £500,000 of the estate. However, if the estate is worth more than £500,000, then Inheritance tax can become a financial burden. However, there are effective strategies to reduce this tax altogether.

Gifting the property

One way to reduce inheritance tax is for your parents to gift the property to you before they pass away. This needs to be done at least seven years before their death (known as the seven-year rule) to avoid the property being included in their estate. However, be aware of the potential capital gains tax implications this action may trigger.

Using Trusts

Setting up a Trust can be an effective way to manage and protect the family home. By placing the property in a Trust, it may not be considered part of your parents' estate, thus avoiding inheritance tax. Consult with a legal expert to understand the complexities and compliance requirements associated with Trusts.

Equity release

Your parents can consider an equity release scheme, often in the form of a lifetime mortgage. This can provide them with tax-free cash from their home while reducing the taxable value of their estate. However, these are complex financial products, and professional advice is recommended. Find out more about equity release in our handy guide.

Annual exemptions and allowances

Take advantage of annual gift exemptions. Each parent can give away a fixed amount each year without the gift being counted for inheritance tax purposes. Over time, these gifts can significantly reduce the value of the estate.

Transferring to a spouse or civil partner

If your parents are married or in a civil partnership, they can transfer assets to each other tax-free. Additionally, when one partner passes away, any unused portion of their inheritance tax threshold can be added to the surviving partner's threshold, effectively doubling the amount that can be inherited without paying tax.

Charitable donations

Encouraging your parents to leave part of their estate to a registered charity can reduce the inheritance tax rate. If they leave 10% or more of the estate to charity, the inheritance tax rate on the remaining estate reduces from 40% to 36%.

Managing a mortgage on an inherited property

Inheriting a property with an existing mortgage can be complicated, however understanding the steps involved can make the process more manageable. Here’s what you need to do:

1. Check for life insurance

   First, determine if the deceased had a life insurance policy that could cover the mortgage. Life insurance payouts are often designed to clear such debts, which can simplify the situation significantly.

2. Review mortgage terms

   If no life insurance is available, delve into the mortgage agreement to understand the lender’s expectations. Look for clauses detailing what happens upon the mortgage holder's death. Generally, mortgage payments are paused until probate is finalised, although interest may still accrue during this time.

3. Settle debts from the estate

   If the deceased had other assets or cash, those resources are usually used to settle the outstanding mortgage before the property can be transferred to you. This will be handled by the executors of the will.

4. Communicate with the lender

   Once all debts and taxes are cleared, and the property is officially yours, you need to address the mortgage if it remains unpaid. Contact the lender to discuss transferring the mortgage to your name. Be prepared for affordability assessments, especially if you already have an existing mortgage on another property.

5. Consider your options

   There are a few pathways you could take:

   • Refinancing: Depending on your financial situation, refinancing the mortgage under your name might be an option.

   • Selling the Property: To avoid taking on another mortgage, you might choose to sell the property and use the proceeds to pay off the remaining mortgage balance.

6. Seek professional advice

   Navigating inherited property with an outstanding mortgage can be complex. Consulting with a mortgage broker can provide personalised advice and help you explore the best options based on your specific circumstances.

Making the decision: Keep, rent, or sell an inherited house?

Inheriting a house brings both opportunities and decisions. The main options you'll face are keeping it, renting it out, or selling it. Each comes with its own set of considerations.

Keeping the house

Deciding to keep the property as your own residence may be emotionally satisfying and nostalgic. However, think about:

How to transfer ownership of an inherited property

Transferring ownership of an inherited property involves a series of legal steps. Here's a step-by-step guide to help you navigate the process:

1. Obtain the death certificate: First, secure the death certificate of the deceased. This document is essential for moving forward with any legal procedures. You can get it from the funeral home or local health department.

2. Complete the probate process: Ensure the executors of the will have obtained probate. This legal document allows them to manage the deceased's estate.

3. Identify necessary forms: You'll need specific forms to transfer the property. These forms are required by the Land Registry and can typically be found on your local council's website.

4. Complete the forms: Accurately fill out all required sections. Include details about the property, the executors, and the beneficiaries.

5. Submit required documents: Along with the forms, you may need to provide additional documents, such as the probate certificate and proof of identity.

6. Pay any fees: Be prepared to pay any associated fees, which can vary depending on the property's value and location.

7. Wait for confirmation: Once submitted, the Land Registry will process the transfer. This may take several weeks, after which you'll receive confirmation that the property is now in the beneficiary's name.

8. Insure the property: Update the property insurance policy to reflect the new ownership. Contact the insurance company to adjust the policy details and ensure you're appropriately covered.

Following these steps will help ensure that the ownership transfer of an inherited property goes smoothly and is legally sound.

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Renting out the property

What to consider when renting out an inherited property

Renting out an inherited property can be a smart way to generate additional income, however, it it's important to weigh several key factors before taking the plunge to ensure it's both a profitable and manageable venture.

Market demand

Is there a high demand for rental properties in that area? If not, you could be left with the property uninhabited for long periods of time.

Financial implications

You may need to handle outstanding mortgages, property taxes, and maintenance expenses. Consult a financial advisor or tax professional to understand how the rental income will impact your financial situation and tax obligations.

Legal responsibilities

You must comply with local landlord-tenant laws, which can vary widely depending on your location. You may wish to consult a legal professional or familiarise yourself with regulations concerning tenant rights, lease agreements, eviction processes, and safety codes to ensure you're fully compliant.

Property management

Decide whether you want to manage the property yourself or hire a property management company. Managing it yourself can save money but will demand your time and effort. On the other hand, hiring a property management firm can be costly but can help streamline tenant screening, rent collection, and maintenance issues.

Tenant screening

Think about tenant screening. It's crucial to find reliable renters who will respect your property and pay rent on time. Use background checks, credit checks, and references as part of your screening process.

Insurance coverage

Ensure you have the right insurance coverage. Standard homeowner's insurance may not be sufficient when you start renting out a property. Look into landlord insurance, which covers property damage, liability, and loss of rental income. Find out how you can get an insurance quote with our partner One Click Cover.

Selling the house

Selling the property can provide a significant financial boost and might be the most straightforward option, especially if you don't have any emotional ties to it. Here are the key points:

Ultimately, whether you keep, rent, or sell the inherited house depends on your financial goals, emotional attachments, and the local market conditions. Make sure to weigh each option carefully and consult professionals where necessary.

Inheritance tax gifts, reliefs and exemptions

Married couples and registered civil partners are exempt from inheritance tax, as long they live in the UK. People in certain careers are also exempt if they die in active service, including police, paramedics, firefighters, members of the armed forces, and humanitarian aid workers. This exemption also applies if an injury sustained in active service leads to a person’s death later in life.

Annual exemption

There are some rules on giving gifts. This means that each year you can give away up to £3,000 worth of tax-free gifts – including money, stocks and shares. This sum can be rolled over for a maximum of one year if you don’t gift the full amount in the first year.

However, some gifts might be taxed after your death. Your loved ones won’t have to pay inheritance tax on your gifts as long as you live more than seven years after you make the gift. This is known as the seven-year rule.

Small gift allowance

There’s a small gift allowance, that enables you to give as many gifts of up to £250 per person as you want each year. However, you shouldn’t have used another gift allowance on the same person.

Other gift allowances:

Gifts for weddings or civil partnerships

Each tax year, you can also make a tax-free gift to your loved ones if they’re getting married or starting a civil partnership. More specifically, you can give up to:

You can combine a wedding gift allowance with any other allowance, except for the small gift allowance.

Gifts to charities

Donations to registered charities can reduce the taxable value of your estate. If you decide to leave 10% or more of your estate’s ‘net value’ to a charitable organisation in your will, the inheritance tax on some of your assets can be reduced. Instead of the standard rate, your estate may only need to pay 36% on the eligible portion. 

You can make gifts to organisations such as charities, museums, and universities, which are exempt from inheritance tax.

Gifts to help with living costs

You could offer financial support without paying tax to an elderly dependent or child in full-time education if they’re struggling financially.

Inheritance tax reliefs explained

Inheritance tax does not only apply to the estate you leave behind when you pass away. It can also affect certain gifts made during your lifetime. However, some reliefs can significantly reduce the tax burden.

What is taper relief?

Taper relief is available for gifts made within seven years before your death (the seven year rule). The relief reduces the inheritance tax on these gifts the longer you survive after making them. For example:

What is business relief?

Business relief helps lessen the inheritance tax on businesses or business interests. You might be able to pass on these assets free of tax or with a reduced tax bill, depending on specific conditions. It’s an important relief for those passing on family businesses or shares in a company.

How does business relief affect inheritance tax?

Business relief can significantly reduce the amount of inheritance tax due on certain business-related assets.

Types of assets eligible:

Key points:

Business Relief provides a legal and effective way to minimise inheritance tax, ensuring that more of the business's value goes to your heirs. By strategically planning and using this relief, you can preserve your family's wealth and maintain the continuity of the business across generations.

Agricultural relief

If your estate includes agricultural property, such as a farm or woodland, Agricultural relief could be vital. This relief can allow for significant reductions in inheritance tax, helping to preserve family-owned farms across generations.

You can research the relief available for agricultural property further by visiting the guidance page from gov.uk.