In the UK, inheriting a property and paying any tax on it will often depend on the total value of an estate and the application of specific allowances and reliefs. For many of those who inherit property, particularly when inheriting a family home, understanding these details can prevent unexpected tax burdens and with appropriate planning, potentially avoid them entirely.
Whilst explaining how and when an individual may be required to pay inheritance tax on a party is important, it is equally essential to understand exactly what inheritance tax is before we begin to focus specifically on when and how this tax applies.
What Is Inheritance Tax?
Inheritance Tax is a tax on the estate (property, money, and possessions) of a person who has passed away. In most cases, the beneficiaries of the deceased’s estate have six months to pay any outstanding balance due to HMRC, or else face interest charged on any amount owed. Beneficiaries must work out the total value of the deceased estate and calculate how much inheritance tax is due before they make any payments.
Typically, Inheritance Tax is charged at 40% on any amount exceeding a specific allowance known as the nil-rate band. If the total estate of the deceased, including all properties, is valued below this threshold, then no tax is payable, however, when the estate’s total value exceeds this threshold, tax may be due on any amount above this level.
The nil-rate band is a threshold that applies to all estates, but an additional allowance exists specifically for property intended to be passed on to direct descendants, known as the Residence Nil-Rate Band (RNRB). The RNRB is currently set at £175,000, which when combined with the standard nil-rate band – set at £325,000 for the 2024/25 financial year – means a parent’s estate can potentially pass on for £500,000 free from Inheritance Tax, provided the family home is included in the inheritance.
This additional allowance only applies if the home is left to a direct descendant, such as a child or grandchild. If the property is left to someone else, such as a sibling or friend, the RNRB does not apply, reducing the total tax-free threshold to £325,000 and potentially leading to a higher tax bill. One critical feature of the Inheritance Tax system is the transferability of unused allowances for married couples and civil partners. If one partner dies and doesn’t fully use their Inheritance Tax allowances, these can be transferred to the surviving partner.
For example, if the first parent’s estate didn’t reach the £325,000 nil-rate band, or if the RNRB wasn’t fully utilised, the unused portion can be added to the second parent’s allowance. Upon the second parent’s death, the combined tax-free allowance could be as high as £1 million. This can significantly reduce or eliminate the tax burden on estates valued up to £1 million when including the family home, a relief measure specifically designed to protect inheritances passed directly to children or grandchildren. However, for estates exceeding £500,000 for individuals or £1 million for couples, paying Inheritance Tax becomes far more likely.
Do You Have To Pay Inheritance Tax On Property?
If a parent’s estate, including the family home, totals £700,000 and the combined nil-rate band plus RNRB is £500,000, Inheritance Tax will be applied to the remaining £200,000. At the standard rate of 40%, this would mean a tax payment of £80,000 on that additional amount. For particularly high-value estates, the RNRB gradually decreases once the estate value exceeds £2 million.
This reduction, known as tapering, lowers the RNRB by £1 for every £2 that the estate exceeds the £2 million threshold. As a result, estates valued above £2.35 million lose the RNRB entirely, returning the tax-free allowance to the basic nil-rate band of £325,000. Estates in this higher range can therefore face significant Inheritance Tax Bills, given the 40% rate applied on amounts above the lower threshold.
Beyond passing on the home through inheritance, some parents consider gifting property to their children during their lifetime to reduce potential Inheritance Tax liabilities. However, this approach comes with considerations. When a property is gifted, it remains subject to Inheritance Tax if the parents do not survive for seven years after the gift is made. This is known as the "Seven-Year Rule."
This rule applies a sliding scale, known as taper relief, to reduce the amount of Inheritance Tax owed based on the number of years between the gift and the person’s death. If the parent dies within three years, the full 40% tax rate applies, but if they survive between three and seven years, the rate gradually decreases, reaching 8% in the final year before the gift becomes entirely tax-free.
A further consideration when gifting property is the “Gifts With Reservation” rule, which states that if parents give away a property but continue to live in or use it without paying the market rent, the gift will still be considered part of the estate and subject to Inheritance Tax. However, if they pay the market rent whilst living at the property, the gift can be considered fully given and will not count toward the estate’s total value after the seven-year rule.
If the parents later need to live in the home due to illness or old age, they can remain without affecting the gift’s inheritance Tax status, provided they meet the seven-year condition for gifting the property away. For parents who sell or downsize their home but wish to pass on the proceeds, the RNRB may still apply under specific circumstances.
This benefit is known as “downsizing relief,” and allows the estate to use the RNRB if the original property has been sold, but the equivalent value is passed to children or grandchildren. The relief ensures that the tax benefit associated with a primary residence is not lost if the home is sold before death. It is a valuable planning tool for parents who may need to downsize while intending to provide a significant inheritance.
Other Reliefs From Inheritance Tax
In cases where the family home forms part of a working farm or business, additional reliefs may further reduce Inheritance Tax liability. Agricultural Property Relief, for example, allows up to a 100% reduction in the value of agricultural property used within a farm business, such as employee housing or storage facilities, which can eliminate Inheritance Tax obligations on qualifying property.
Business Relief, although slightly more complex, can reduce the taxable value of business assets by up to 50% however, covenants are most strict about the property qualifying for business relief rates, and a clear foundation is required that evidences the use of the property for employee accommodation. Estates that include farm or business properties may therefore benefit from both specialised reliefs that can drastically reduce or eliminate tax liability due on these valuable property assets.
Whether is a question of paying or not paying Inheritance Tax on property, some clear rules and regulations govern the process which makes it feel less complicated. By understanding how exemptions can be applied, beneficiaries can mitigate or avoid paying tax on many inherited properties.
For parents and families, forward planning and a clear understanding of the rules around the nil-rate band, RNRB, and specific rates of relief can help avoid substantial tax burdens. Consulting a financial advisor specialising in inheritance tax can provide strategies to minimise the impact of inheritance tax, ensuring valuable assets are passed on without incurring taxes.
