It is hard to think about giving away your assets while you are still alive, but doing so can help save Inheritance Tax when you die. In this article, head of private client Elena Stylianou explains how the ‘seven-year rule’ enables you to gift assets during your lifetime tax-free or at a reduced tax rate.
How is Inheritance Tax charged?
First, let’s look at how Inheritance Tax is charged. The current Inheritance Tax position is that a deceased’s estate is taxed at 40% on the value of the estate above the tax-free allowance of £325,000, subject to certain exemptions.
This figure increases to £500,000 if the estate includes a main residence property left to direct descendants of the deceased (such as children) and the value of that property is less than £2m. This additional tax-free allowance of £175,000 is known as the ‘residence nil rate band’. If the value of the property is over £2m, the residence nil rate band will taper.
The ‘seven-year rule’
Under the current law, any assets gifted seven years before an individual’s death will be exempt from Inheritance Tax. The gift needs to be an outright gift, which means the person making the gift may no longer benefit from it.
For example, you are not entitled to gift your home to someone and remain living in the home rent-free as if it were still your own. This will be deemed to be a ‘gift with reservation’, and the seven-year rule will not apply. It is better to make a monetary gift, a gift of shares or gifts of items such as watches, jewellery and artwork.
The seven years start from the date the gift is made, so the sooner this is, the better. If the person making the gift survives seven years from the date of the gift, then the gifted assets will no longer fall within their estate on death.
Taper relief
If an individual who has made a gift does not survive seven years from the date the gift is made, taper relief may apply. To benefit from taper relief, the person who made the gift must survive at least three years from the date of the gift. If they die within three years, the gift will form part of the estate and be subject to 40% Inheritance Tax.
However, if the person making the gift survives more than three years, the level of Inheritance Tax will reduce yearly. The table below shows how taper relief is applied each year the person making the gift survives. The tax payable will be on amounts that exceed any tax free allowance.
|
Number of years before death |
Taper relief % |
Tax payable on gifts |
|
0-3 years |
0% |
40% |
|
3-4 years |
20% |
32% |
|
4-5 years |
40% |
24% |
|
5-6 years |
60% |
16% |
|
6-7 years |
80% |
8% |
|
7+ years |
No tax |
0% |
Before making any gifts, it is wise to speak to the person receiving the gift about their potential liability to pay Inheritance Tax. If the person dies within seven years of making the gift, the gift becomes taxable. If there are not enough assets in the deceased’s estate to pay the Inheritance Tax, the receiver of the gift may be liable for the Inheritance Tax due on the gift. Therefore, it is always important to weigh the pros and cons of making a gift during your lifetime.
If you would like to discuss making a Will, please contact Elena Stylianou at ES@portner.co.uk.
Disclaimer: The above is merely general guidance and should not be relied on as formal advice. We suggest you take professional legal advice before taking any action in relation to the issues discussed above.
For more information visit our website: https://www.portner.co.uk
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