Inheritance Tax

Inheritance Tax – will you be forced to sell the family home?

More families are falling into the Inheritance Tax (IHT) net due to rising property prices and frozen allowances. If your family home is likely to push you over the IHT threshold you may need to take action. Peter Webb, our Head of Tax Advisory, looks at what you can do, and shares the unfortunate story of a family who didn’t plan ahead early enough.

As ever, the stats don’t lie – last year IHT revenues between April and December topped a staggering £5.7 billion – £400 million higher than same period in 2022. And with forecasts suggesting that the amount the government claws from IHT will hit £7.6 billion this tax year (up £1 billion on last year) it’s no surprise that more heirs than ever before will face this punishing tax.

Changes to legislation have long been called for, but for now IHT remains a challenging issue. The Conservatives – given the general election – are unlikely to have time to make any immediate changes and Labour, who look to be on course to be in power from later this year, have already confirmed they will reverse any revisions which are rushed in.

An optional tax

Many UK taxes are mandatory and there’s no escaping them. IHT is different and there are a number of ways that careful financial planning can help reduce or eliminate it. There are also some common misconceptions, including that you’ll be forced to pay tax on the family home if it’s worth more than £325,000 (the current IHT allowance). But this simply isn’t the case; you can transfer your main property to your partner, or children (including adopted, foster or stepchildren) using both the current allowance and the Main Residence Nil Rate Band of £175,000. Here’s an example of how this could work in practice:

James dies, leaving his family home worth £850,000 to his wife Sally. When Sally dies two years later the property is inherited by the couple’s daughter, Charlotte. Its value is now £895,000, and Charlotte can take advantage of James’s Nil-Rate Band of £325,000 plus the Main Residence allowance of £175,000 together with the same allowances for Sally – allowing Charlotte to inherit the home free from IHT.

But if your home is valued significantly more the stakes can be higher.

The Bailey Family

In 1945 Oswald Bailey purchased a property in Sandbanks, Poole for £7,000. The family home was passed down through the generations, with Oswald leaving the property to his son Frank. Frank and his wife Lalage raised their four children there, and he left ownership to her when he died in 2005. She, in turn, left the family home to their four children. On Lalage’s death the family home was valued at £9 million, with the four children faced with a collective £3 million IHT bill. Given the circumstances, they have since been forced to put the property on the market, losing their much loved family home. IHT could have been reduced, or even eliminated, had Frank and Lalage gifted the home to their children ahead of their death, or taken other steps to protect it.

So, what could you do with your family property?

There are a number of options if you’re keen to minimise the amount of IHT which your family might face. Here are some of the most useful steps:

Gifts – if you’re planning for your child or children to inherit the family home then you can gift it to them during your lifetime. There are a couple of caveats – you will have to survive for seven years, although there are rules which taper the IHT depending on how long you live after gifting. And if you choose to remain living in the home, you’ll have to pay your children market rent. Bear in mind this means that their income may rise, which could push them into a different tax bracket themselves and may also mean they will face higher stamp duty costs when they purchase their own home as well.

Downsize – another alternative is to downsize your property and gift any profits during your lifetime. Again, the seven-year rule still applies.

Trusts – putting the family home into trust means it won’t belong to you but can shelter the family home from IHT. Trusts can be complicated, and there are different types which suit different family situations. Seeking expert advice is critical.

Life insurance – whole of life insurance policies can be set up to cover the costs of any potential IHT bill for your heirs, paying a lump sum on death. This can offer a way to avoid your heirs facing a significant bill, which could force an unwanted sale of the family home.

With standard rates of IHT in the UK fixed at 40%, this area of Estate planning is one which benefits from careful thought. Don’t forget that IHT is also calculated based on the total value of your Estate, including any property, investments and any other assets, so it’s worthwhile taking some time to consider your options – and planning ahead.

To discuss any aspect of your Estate planning with one of our team please contact your nearest office.