Understanding Inheritance Tax (IHT): The Basics and Reliefs Available
- matbriars
- Mar 23
- 5 min read
What is Inheritance Tax?
Inheritance tax (IHT) is a tax on the estate (property, money and possessions) of someone who has died. The normal rate of IHT tax is 40% on the value above the tax-free threshold.
There is nothing to pay if:
the value of your estate is below the tax-free threshold (£325,000 in 2024/25)
you leave anything above the tax-free threshold to your spouse, civil partner, a charity or a community amateur sports club
However, you may still require an accountant to report the value of an estate even if it is below the tax-free threshold.
Example:
You receive an estate worth £525,000. The taxable amount above the tax-free threshold is £525,000 less £325,000 = £200,000. At 40% the amount of tax due is £80,000.
Increase the tax-free threshold to £500,000 by passing on a home
When a home is passed to a spouse or civil partner on death no inheritance tax is due.
If your home is inherited by a direct descendent they may apply an additional Residence Nil Rate Band (RNRB) to the death estate calculation (£175,000 2024/25).
A direct descendent is considered to be a child, grandchild, great-grandchild - including adopted, foster, stepchildren and spouses or civil partners of such a direct descendent.
There is no minimum ownership or occupation period and the property does not need to be the deceased's main home.
However, if the total death estate exceeds £2 million (calculated as assets less liabilities but before any exemptions or reliefs) the RNRB is tapered by £1 for every £2 which the estate exceeds £2 million. Therefore, there is no RNRB where the total death estate is value at £2.35 million or above.
Example:
You receive an estate which includes a £950,000 house, plus other assets of £1.25 million. Total debts and funeral expenses cost £80,000.
The value of the estate is: £950,000 plus £1.25 million less £80,000 = £2.12 million.
The portion above £2 million is £120,000. Therefore, the RNRB will be tapered by £120,000 / 2 = £60,000.
RNRB is calculated as: £175,000 less £60,000 = £115,000.
Lifetime gifts
Some gifts made during the donor's lifetime are exempt, others are considered to be Chargeable Lifetime Transfers (CLTs) and the remainder are classed as Potentially Exempt Transfers (PETs).
Exempt Transfers:
These include transfers to spouses and civil partners, gifts to charities and gifts to political parties.
Transfers in consideration of a marriage or civil partnership are exempt where the transfer does not exceed:
£5,000 - by a parent
£2,500 - by a remoter ancestor or one of the individuals being married
£1,000 - other relationship
There is a small gift exemption limited to £250. This cannot be used to exempt part of a larger gift.
Normal expenditure out of income is also exempt where it can be proven that the transfer is a regular pattern of giving (or was given with the intention of it being a regular donation). The donor must be left with sufficient income to maintain their standard of living.
Individuals are also entitled to an Annual Exemption (AE) amount which is currently £3,000 (2024/25). This is used against transfers in chronological order. Unused amounts can be carried forward for one year but the current year AE is used before any carried forward amount is applied. The AE is the last exemption to be applied.
Chargeable Lifetime Transfers (CLTs):
Most CLTs include gifts made to trusts, but may also include transfers to a company - especially where the company is considered to be a close company.
Either the trustees or the recipient must pay the tax calculated as 20% of the net estate (less exemptions and NRBs).
If the donor pays the tax themselves a grossed-up rate of 25% is used and the tax paid is reflected in gross value of the gift for the recipient.
Potentially Exempt Transfers (PETs):
Gifts that are neither exempt or considered CLTs are treated as PETs. These have the potential to become exempt transfers by benefitting from taper relief, which reduces the amount chargeable as follows:
Period between gift and death | Chargeable % |
|---|---|
Less than 3 years | 100% |
More then 3 years but less than 4 years | 80% |
More then 4 years but less than 5 years | 60% |
More then 5 years but less than 6 years | 40% |
More then 6 years but less than 7 years | 20% |
More than 7 years | 0% |
Inheritance Tax Reliefs
When calculating the death estate, other tax reliefs may be available:
Transfer of Nil Rate Bands:
The Nil Rate Band (£325,000) and Residence Nil Rate Band (£175,000) can transfer to a surviving spouse or civil partner. This can give a maximum relief of: (£325k + £175k) x 2 = £1 million.
Fall in Value Relief:
If an asset gifted during the donor's lifetime is either sold for less than the original transfer value, or the market value is lower at death, the taxpayer can elect for tax to be based on the lower value.
(Note: when calculating available NRB on other gifts the original transfer value would still be used)
Quick Succession Relief (QSR):
If an asset or estate is taxed twice within 5 years QSR is available and is calculated as:
QSR = Tax paid on earlier transfer x (Net transfer / Gross transfer) x Chargeable %
(Note: the net transfer is the amount actually received and the gross transfer is the amount chargeable to IHT)
Business Property Relief (BPR):
Relief at either 50% or 100% is available where there is a transfer of qualifying business property. This applies to lifetime gifts as well as to the death estate.
If there is any value remaining after the relief has been applied, other exemptions can be used (e.g. Annual Exemption).
Business Property | Relief % |
|---|---|
Whole sole-trader or partnership trading business | 100% |
Shares in an unquoted trading company (including AIM listed) | 100% |
Shares in a quoted trading company where the donor had control | 50% |
Business assets (land, buildings, plant & machinery) owned by the donor and used in the company they controlled | 50% |
Assets must have been owned for at least 2 years prior to the transfer, with the following exceptions:
The assets replace other qualifying assets and together were owned for at least 2 of the previous 5 years
Ownership periods are combined for transfers on death between spouses and civil partners
Where there are successive transfers of the same asset, one of which was on death and the first transfer qualified for relief
BPR does not apply where:
The business consists wholly or mainly of dealing in securities, stocks, shares, land or buildings, or making or holding investments
There is a contract in place to sell the asset
BPR is also restricted where the business being transferred holds excepted assets - items not wholly used for the purposes of the business, or required for future use. Examples include large cash balances or investments.
In order for BPR to be available on the death tax calculation for lifetime gifts:
The recipient must still own the property (or qualifying replacement property)
The property must still qualify for BPR
Double Taxation Relief:
Relief may also be available for overseas assets which have already attracted foreign tax.
Up to 5% of the value of the foreign asset can also be deducted from the death estate to give relief for additional administration costs associated with the transfer of the asset.
Reduced rate for charitable giving:
Where at least 10% of the net chargeable estate has been gifted to a charity IHT is charged at 36% rather than 40%.
Points to note:
Strong financial advice and planning in liaison with a qualified accountant can help you to discover the most tax-efficient way of managing your estate.
To maximise IHT reliefs and allowances it is important to start planning early.
This document is a simplified helpsheet and careful research should be completed if you are unsure.
Need more information? Contact us today to find out more.
Verifiable Accounts - Professional Financial Accountants providing Tax Preparation and Accounting Services
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