Inheritance Tax / Tax

How to protect your home from inheritance tax

Many people have a significant proportion of their wealth tied up in property. And if you’re keen to pass on the family home, protecting it from Inheritance Tax is likely to be a particular concern. Peter Webb, our Head of Tax Advisory, explains what you can do to shield your home from this punishing tax.

UK Inheritance Tax (IHT) is a further tax (of up to 40% after available allowances) on income and gains which you’ve most likely already paid tax on during your lifetime. It generally tends to be paid by your estate when you pass away, although if you leave everything to your spouse or civil partner, provided you share the same domicile status, IHT won’t apply. It’s only when the second one of you passes away and your joint estate is left to your intended beneficiaries that IHT potentially applies.

So the first step in any plan to reduce IHT on your home is to understand what your liability could be. Once you know how much Inheritance Tax you’re likely to pay you can then make a plan to reduce the bill.

There are several ways to reduce your IHT liability:

  • Spend your money: what you spend during your lifetime reduces the size of your estate, and therefore lessens your bill too
  • Gift assets: this can be done through gifts to your intended beneficiaries during your lifetime directly or through a trust if, for example, it’s not the right time for a child to receive a significant gift. Certain conditions need to be fulfilled and you’ll need to allow seven years before IHT is definitely out of the picture. There might also be ways to gift without needing to wait this seven years through various allowances and reliefs.
  • Insurance: this can help manage your IHT liability and whilst it may not be cost effective for your whole liability it can help with specific assets. So you may be able to cover the possible IHT due if you need to survive seven years for an asset you’ve gifted to become exempt.
  • Investments: some investments benefit from specific IHT reliefs. For example UK pensions, some specific overseas pensions, business assets (including shares in qualifying companies) and the value of qualifying agricultural property.

IHT and your home

With your home likely to be one of most valuable assets, it’s important to properly plan for IHT. This is particularly relevant given UK property’s continued increase in value, which is turn is bringing more families into the scope of IHT.

It’s now very difficult to hold your family home in a trust or a company in a tax efficient way. As a result traditional IHT planning routes are less effective than they used to be. Even if you aren’t UK domiciled (and only face UK IHT on UK assets and not those held overseas) it’s no longer possible to shelter your UK property from IHT by holding UK property in an overseas structure.

Leaving aside the option of making an outright gift of your home to your children during your lifetime, there are still several steps you can take to reduce the IHT which might apply if your home forms a significant part of your estate.

Using allowances

There is a specific residence allowance available when you leave your home to your ‘direct lineal descendants’, usually your children. This is called the ‘residence nil rate band’ and can be worth up to GBP350K for a couple. When this additional allowance is added to other “nil rate bands” available it could mean that a couple can leave up to GBP1m of assets to the next generation without paying IHT.

If your estate exceeds this amount, IHT can also be paid on an inherited property by instalments over 10 years. Whilst this doesn’t reduce the IHT bill, it does at least give your beneficiaries time to pay the tax without, perhaps, the need to sell the home they have inherited.

Gifting your home

Depending on your family circumstances it’s sometime possible for you to gift a share of your property to your children during your lifetime and for the share you have gifted to be excluded from IHT in your estate. To be effective various conditions need to be met, and your offspring must live in the property with you.

Alternatively, you can gift your entire home to your children during your lifetime. Once various conditions have been met the value of your home will not then attract IHT when you pass away. The downsides for this strategy include loss of control of your home, the need to pay a regularly reviewed market rent to live there (to avoid complex “gift with reservation of benefit” rules) and the rent you pay becoming a taxable income in the hands of your children.

Other options

Taking out insurance against a possible IHT bill on the value of your home in your estate is also an option. A financial planner can help you understand whether or not this will be cost effective. And finally, don’t forget that loans and mortgages can reduce the value of your home when any IHT bill is calculated. There are various conditions that need to be met to ensure that any borrowing against your home is treated as an IHT deduction and the loan or mortgage will of course also need to be repaid.

These are just some of the more common ways which could be used to protect your home from IHT. To discuss a specific plan based on your own circumstances please contact your nearest office.