If you own property it likely makes up a significant portion of your total overall wealth. But Inheritance Tax (IHT) could one day cost your loved ones a significant sum of money. That’s why it’s important to consider how you might pass it on to the next generation of your family in the most tax-efficient way possible. There’s a big difference in how much tax would be due by gifting a property in your lifetime compared to passing it on after your death.
WHAT IS INHERITANCE TAX (IHT)?
IHT is a tax on your wealth and assets you pass on after your death. The standard rate of IHT is currently 40%. However, no IHT is currently due on wealth or assets left to your spouse or registered civil partner. Also, no IHT is payable on the first £325,000 of your wealth or assets passed on to others (this is called your Nil-Rate Band, or NRB), or an additional £175,000 of property wealth. This is called your main Residence Nil-Rate Band, or RNRB, and it can be used against one property only. Both bands have now been frozen until April 2026. If you’re a surviving spouse or registered civil partner who has inherited everything from your deceased partner, you’ll be entitled to their NRB and RNRB also, meaning you can pass on a total of £650,000 in wealth and assets plus up to £350,000 of the value of one property. On the death of the second partner, your combined allowance could potentially reach up to £1m of allowances before your heirs have to pay IHT, although the combined main RNRB of £350,000 can only be set against the main residence. This allowance is gradually reduced if your estate is worth more than £2m and completely exhausted for joint estates worth more than £2.7m.
HOW MUCH TAX WILL BE DUE IF I PASS ON A PROPERTY AFTER MY DEATH?
This depends on various factors, one being the total size of your estate. If you have only one property to pass on, which is worth less than £175,000, or the total value of your estate is less than £500,000, you may be able to pass it on without incurring a tax charge. But if you have more than one property, it’s very possible that IHT will be charged at 40% of the total property value.
WHEN WOULD IHT NOT BE CHARGED?
You must survive for seven years after making a gift of property for it to become IHT free. If you die within three years, IHT would be charged at the full rate. If you die after three years but within seven, it would be charged at a tapered rate. You must also not profit from the property in any way during your lifetime, for example, by retaining the right to live in it. This would be considered a ‘gift with reservation of benefit’ and would incur an IHT charge after your death.
HOW MUCH IS CAPITAL GAINS TAX (CGT)?
CGT is a tax on assets you sell at a profit during your lifetime. There are different rates of Capital Gains Tax which depend on the item you’re selling and your tax band. If you only own one property, you won’t pay CGT when you sell it. But, for any additional properties, you’ll pay 18% CGT if you’re a basic rate taxpayer, or 28% if you’re a higher or additional rate taxpayer. CGT is only payable on profits above your personal allowance, which in the tax year 2021/22 is £12,300 (or £24,600 for married couples on assets they jointly own). CGT can apply to assets you give away as well as assets you sell. So, gifting a second property to your child could incur a tax charge.
HOW MUCH CGT WILL BE DUE IF I GIFT A SECOND PROPERTY IN MY LIFETIME?
As a parent gifting a second property to a child at no cost, you would still have to pay CGT. This would currently be charged at 18% or 28% (depending on your tax band) of the difference between the current property value and the price you paid for it, if this exceeds your personal allowance.
WHAT ARE MY OTHER OPTIONS?
One option is to transfer the property into a trust. This strategy is only possible if the property is mortgage-free, and is most effective if the property value is within the NRB (i.e. less than £350,000). For any property value that exceeds the NRB, you will need to pay an IHT charge. Trust law is extremely complicated so you should seek specialist professional advice if you wish to explore this. Another option, if you own property within a limited company, is to pass on shares in that limited company. If your company operates within the rules for Business Property Relief, shares in it may be eligible for 50% or 100% IHT relief. Again, you should seek specialist professional advice before taking any action.