In the event of the death of one’s parents, Inheritance Tax can be a significant concern for the beneficiaries of the estate. Whether it is the family home or additional properties left behind as part of a last will, multiple factors determine if one must pay inheritance tax on parents' house and, if so, what amount has to be paid.
Below we look at how inheritance tax works, the thresholds involved, and specific scenarios that may trigger or reduce the tax paid on the family estate.
How Inheritance Tax Works
Inheritance Tax is a tax on the (property, money, and possessions of someone who has passed away. In the UK, Inheritance Tax is calculated based on the estate's total value and in most cases, it is charged at a rate of 40% on amounts above a specific threshold known as the "nil-rate band."
For the 2024/2025 tax year, the nil-rate band for Inheritance Tax is £325,000. This means that if the total value of your parent's estate is less than £325,000, no Inheritance Tax is payable after their passing. If the estate exceeds this threshold, inheritance tax may be due on any amount above £325,000 although, some reliefs and exemptions can reduce the tax due on an estate significantly, potentially, removing the need to pay any inheritance tax altogether.
One significant relief available is the Residence Nil-Rate Band (RNRB), which specifically applies to the family home. For the 2024/2025 tax year, the RNRB is set at £175,000. This relief can be applied when parents decide to leave their home to their children in their will. Combining the standard nil-rate band (£325,000) with the RNRB (£175,000), a parent's estate can potentially pass down to their children for up to £500,000 free from inheritance tax.
If one parent has already passed away and their estate was not fully taxed due to an unused nil-rate band, these allowances can be transferred to the surviving parent, meaning further savings on inheritance tax can be applied. When the second parent passes away, their estate may benefit from up to £1 million of tax-free allowances if all the thresholds are met, providing a massive relief for their children from inheritance tax.
Situations Where Inheritance Tax May Be Due on a Property
While many estates will benefit from exemptions and reliefs, there are circumstances in which Inheritance Tax may still be payable on your parents' house. If the total value of the estate, including the house and any other assets (including savings, shares etc), exceeds £500,000 (or £1 million for couples), Inheritance tax will need to be paid at the standard, 40% rate. For example; if your parents' total estate, including the family home they wish to leave you, is valued at £700,000 and the nil-rate band is £500,000, IHT will be due on the remaining £200,000.
It is crucial to remember that the RNRB only applies when the family home is passed to direct descendants. If the property is left to someone other than a direct descendant, the RNRB cannot be claimed, reducing the tax-free threshold to £325,000 and leading to a higher inheritance tax bill than if it were passed down directly to children or grandchildren.
If your parents' house is particularly valuable, the RNRB begins to taper off once the total estate exceeds £2 million. For every £2 the estate exceeds over £2 million, £1 of the RNRB is lost. This means that estates above £2.35 million will lose the RNRB entirely, and can be taxed at the full 40% on amounts over the £325,000 threshold, leading to a significant inheritance tax bill.
Gifting Away Property
In some cases, parents may choose to gift away their home to their children during their lifetime as a means of avoiding paying inheritance tax. However, such gifts will not be exempt from inheritance tax if the parent passes away within seven years of making the gift to their children. This is known as the “Seven-Year Rule,” and applies a sliding scale of Inheritance Tax based on how long ago the gift was made called “Taper Relief”.
If the parents survive for more than seven years after the gift, no Inheritance Tax will be due, however, if the parents die within three years of giving the gift, the standard rate of 40% will still apply. All other rates differ as follows:
|
Years between gift and death |
Rate of tax |
|
3 to 4 years |
32% |
|
4 to 5 years |
24% |
|
5 to 6 years |
16% |
|
6 to 7 years |
8% |
If parents give away any part of their estate to their children, they must be aware of the “Gifts With Reservation” rule. If a person chooses to gift property from their estate but continues to use it in the years they remain alive, either as a primary residence or, as a holiday home, for vacations, then the property will not be considered a gift and it will still count towards the overall value of the estate.
For parents choosing to gift away any property including their family home, to their children, they will need to prove they have not been using the property for the seven years since they made the gift. However, if they continue to live in the family home and pay the market rent for the property, then the gift is allowable and won’t be included in the final estate calculation when inheritance tax is calculated. Additionally, if the parents become unwell or infirm, they can live in the property without this counting as a gift with reservation.
Additional Considerations
If your parents have sold or downsized their home but still want to leave you the proceeds from the sale, the RNRB can still apply. In such cases, the relief can be applied to the sale proceeds, providing it is passed down to a child or grandchild. This allows the estate to claim the RNRB even if the property itself is no longer owned at the time of death.
If the family home is part of a working farm or business, there may be further exemptions available under Agricultural Property Relief or Business Relief. These reliefs can significantly reduce the taxable value of the estate, providing certain conditions are met, with Agricultural Property Relief providing 100% reductions on residences used by workers. It is harder to claim Business Relief on assets, but it is still possible to see up to 50% of the value of a business property reduced from the total value of the estate.
Understanding the thresholds and planning can help minimise the tax burden on inherited properties for both parents and their descendants, ensuring valuable assets that are left behind do not become a financial burden for those who were intended to receive them as a financial benefit.
