How To Use The 7-Year Rule In The Inheritance Tax UK?
For many people in the UK, finding a spot on the property ladder is just out of reach. Thousands of people reach their goal of home ownership, though, when they inherit property. That inheritance, though, doesn’t come without at least a few downsides, and for many, the inheritance tax is one of them. Even if you got your house as a gift in someone’s will, you may still be responsible for the inheritance tax. What is this tax, and how does it apply to your inherited home? This quick guide can help you learn more about the tax, the 7-year-rule, and how gifts fit under tax law in the UK.
A Quick Introduction to the Inheritance and Gift Tax
Most people in the UK pay taxes, but few realise that if they were to receive an inheritance or a gift, then there is a tax to be paid. Inheritance and gift taxes have been around for many years. They are taxes levied against assets that the recipients have received as a gift or via inheritance. In most cases, the inheritance tax is paid on death, while a gift tax is typically paid upon receipt of the gift.
Essentially an inheritance tax is a tax the government places on the property, personal possessions, or cash of the individual who has passed away. It is a one-time tax, and it has to be paid at least six months after the death of the benefactor. Not everyone has to worry about the inheritance tax, though. If the value of the total estate is less than £325,000, there is no inheritance tax. If the value of the estate is higher than that, but everything above that amount is left to a spouse (or partner), or a charity, there’s no inheritance tax on that, either.
This equation becomes a bit more complex if the person has left their home to their children or grandchildren. In that case, the amount one can leave behind increases up to £500,000.
These thresholds matter because the standard inheritance tax rate is quite high – up to 40% – but it’s only charged on the amount that exceeds the overall threshold. The good news is that the beneficiaries themselves don’t have to pay taxes on the inherited property. Instead, your estate typically pays it. That can change, however, thanks to the 7-year-rule.
When A Gift Becomes Taxable
The 7-year-rule shifts any gifts you give from the category of “gift” to the category of taxable property. It works like this. If you give a gift – like property – to someone, they owe no tax on it if as long as you’re alive for at least 7 years after you give it to them. If you die before that period is up, it will be taxed. Gifts that are given three years before the person’s death will be taxed at the maximum rate of 40%. Those that are given in the three to the seven-year range are taxed on the taper relief sliding scale.
If the person who donates a gift passes during the seven years, this gift rule applies to what you gave that person- meaning that the recipient of the gift will probably have to pay the taxes associated with your gift to them. For those individuals who want to avoid this situation, it is important to know that not all gifts will trigger an inheritance tax charge, even if the gift is given while you are alive. The gifts that are exempt from inheritance tax include the following:
- Any Gift to your Spouse or Partner: In general, any gift that you give to your spouse or civil partner who is in the UK avoids inheritance taxes.
- Gifting Money to Children or Others Getting Married: If you give your child a gift to celebrate their wedding or their civil partnership, the inheritance tax will not apply as long as the gift value doesn’t exceed certain limits. Those limits are £5,000 for each of your children, £2,500 for your grandchildren, or £1,000 if you’re giving a gift to someone else.
- Gifts From Your Yearly Earnings: If you make a gift that does not affect your lifestyle, then these gifts are not subject to the inheritance tax. This could include something as simple as a birthday or anniversary present.
- Gifts to Help Your Family: If you donate gifts or pay living expenses for your relatives (e.g., a child, ex-spouse, or dependent relative), these gifts are not subject to the inheritance tax.
- Gifts to Charitable Organisations: Many people give gifts to their favourite charities, museums, universities, hospitals, religions, or community centres. In general, these gifts are also not subject to inheritance tax.
- Gifts to Political Parties: If you donate money to your favourite political party, this is exempt from the inheritance tax. However, the party has to be bona fide, which is commonly defined as having at least two members who have been elected to the House of Commons and at least one who has garnered 150,000 votes in a general election.
In addition to the above exemptions, up to £3,000 on an annual basis is not subject to the inheritance tax. What this means is that every 12 months, you can give a gift of up to £3,000 and not have to pay inheritance tax. More importantly, you are at liberty to carry over exemptions to the following year. However, be mindful that gifts valued over the annual exemption cap of £3000 are subject to the inheritance tax. Finally, there is the small gifts exemption rule which permits all individuals to give a large number of small gifts that fall outside the inheritance tax law each year- this is outside the annual exemption of £3000. These small gifts can’t be more than £250 each, and you can’t have used that exemption for the same person elsewhere.
How much can you gift tax-free? Does it count if you’re gifting property to children or spouses? The 7-year rule can be quite complex, so we’ve put together a list of fairly common questions people have about it.
How much money can you gift?
Currently, the amount you can gift is the same amount excluded by inheritance tax. The inheritance tax threshold in the UK in 2021 was £325,000. That rate doubles for married couples. So, if you’re asking “how much can I gift tax-free?” the answer is anything up to the inheritance tax threshold.
How much can I gift my children over the holidays?
In most cases, the usual gifts that people give to each other over the seasonal holidays or for anniversaries do not count. That’s only true, though, if the gift doesn’t affect your normal standard of living. A gift of a home, though, is likely to do that, even if you give it as a holiday gift.
Do I Pay Tax on Gift Money From My Parents?
The question of who is responsible for the payments on a gift comes into play thanks to the 7-year-rule, too. If you inherited money or property in the more traditional sense, and if the estate from which you inherited it is above the allowance cap, then the estate funds will be utilised to pay the inheritance tax to HMRC. Usually, this is handled by the person who handles the estate itself – sometimes called an executor. Things get more complex if you were gifted money from your parents. When it comes to gifts, if the person dies before the seven years is up, you have to pay the taxable amount to HMRC.
Can I Sell My House to My Son for 1 Pound?
Many people work to get around both inheritance and gift tax by selling their property or possessions for very little money. Legally you can sell your home to your child for any price you want. However, you should be aware that other costs may be involved including inheritance tax, stamp duty and legal costs. Remember, too, that a low-cost home comes with expenses. Things like maintenance and home insurance are with a gift in the UK like that one. And when you sell your home at far below the market price, HMRC considers this to be a taxable gift.
How Much Can You Gift Your Children Normally?
In general, you can give your children as many gifts as you want but some large gifts are subject to tax. The annual tax-gift allowance is £3,000 per year; you can give this sum to just one child or divide it among the other children.
How Much Can You Gift To Others Tax-Free?
£3,000 is the annual tax gift allowance in the UK.
How much money can I give away each year?
In the UK, you are allowed to give money or gifts up to £3,000 per year to one individual or split it between many individuals
How Do I Avoid The Gift/Inheritance Tax Issue
There are many different steps you can take to avoid this issue entirely. One of the best is to consult with a solicitor so you can make a will. In this manner, you can ensure your assets are distributed the way you want them to be. Without it, your assets are distributed in a completely different manner – often according to intestacy rules – and you may not have agreed with where they ended up. As a result, creating a will can help you means that you not only have some control over your assets after you die, but it also means that your spouse, children, and others may be able to avoid some of the inheritance taxes. Your best bet to build a solid wall is to chat with a solicitor about what you’re leaving behind and how best to do so.
Another way to avoid these taxes is to place your assets within a trust. Once you do so, they’re no longer part of your estate, so your heirs won’t pay inheritance taxes on them. You can put them into certain categories, too, like a trust to pay for a child’s education or a trust to help fund their first home purchase, which could be quite useful to help them reach their own property goals in the future.
You can also take out a life insurance policy for the tax bill itself. This is a bit complex, but the way that it works is that you work with a solicitor to calculate what you might owe on your inheritance taxes. Then you take out a life insurance policy to cover that amount. The policy is placed within a trust so that it is tax-free in and of itself, then when you pass, the estate uses the funds from that policy to help pay for the inheritance taxes.
Keeping Your Assets Safe
If you have loved ones looking to achieve a rung on the property ladder with your assets, the single best way to avoid the inheritance tax associated with that or the 7-year-gift rule is to work with a solicitor who can help you ensure that every move you make with your money and your home is carefully protected. The last thing you want is to have your home sold just so your heirs can pay the associated taxes.