Inheritance Tax (IHT) is a tax on the estate of someone who has died and on certain lifetime gifts. It is charged at 40% on the value of an estate above the nil-rate band, with reduced rates for certain transfers. Effective planning can significantly reduce or even eliminate IHT liabilities.
IHT planning should be considered well before death. Lifetime gifts, use of exemptions and reliefs, and proper will drafting can preserve family wealth. Seek professional advice for complex estates.
IHT applies to transfers of value made by individuals, including transfers on death and certain lifetime transfers. Everyone has a nil-rate band below which no IHT is payable. Transfers between spouses/civil partners are generally exempt. IHT also applies to some trusts.
The standard IHT rate is 40% on death. A reduced rate of 36% applies if at least 10% of the net estate is left to charity. Lifetime chargeable transfers are taxed at 20% when made, with a further 20% payable if the donor dies within 7 years (effectively 40% overall).
The nil-rate band (NRB) is £325,000 for 2025/26. No IHT is payable on the first £325,000 of an estate. Any unused NRB can be transferred to a surviving spouse or civil partner, effectively doubling the available NRB to £650,000 for many couples.
The residence nil-rate band (RNRB) is an additional allowance when a residence is passed to direct descendants. As of 2025/26, it is £175,000, tapering for estates worth over £2 million. Like the NRB, it is transferable between spouses.
When the first spouse dies, any unused nil-rate band can be transferred to the surviving spouse. This is not an automatic transfer but must be claimed when the surviving spouse dies. The transfer applies to both the NRB and RNRB.
| Band | Amount | Rate |
|---|---|---|
| Nil-rate band | First £325,000 | 0% |
| Main rate | Above £325,000 | 40% |
| Reduced rate (10% to charity) | Above £325,000 | 36% |
| Residence NRB | Up to £175,000 | 0% |
| Lifetime CLTs | Above NRB | 20% (plus 20% if death within 7 years) |
A Potentially Exempt Transfer (PET) is a gift that becomes exempt if the donor survives for seven years. PETs include most gifts to individuals and most trusts. If the donor dies within seven years, the PET becomes chargeable, though taper relief may reduce the tax.
Chargeable Lifetime Transfers are gifts that are not PETs, primarily gifts to certain trusts. CLTs are immediately chargeable to IHT if they exceed the available nil-rate band. Tax is paid at 20% when the gift is made, with a potential further 20% if the donor dies within seven years.
Certain lifetime transfers are exempt from IHT: gifts to spouses or civil partners, gifts to UK charities, gifts to political parties, and small gifts up to £250 per person per tax year. The annual exemption (£3,000) also provides exemption for gifts up to this amount each tax year.
Gifts that are part of normal expenditure from income are exempt from IHT, provided they do not reduce the donor's standard of living. This exemption covers regular gifts like Christmas or birthday presents, regular premiums on life insurance policies, or ongoing support payments to family.
PETs are only exempt if the donor survives for seven years. If death occurs within this period, the PET becomes chargeable and may create an unexpected IHT liability. Records of all PETs made within seven years of death must be disclosed.
On death, IHT is charged on the value of the estate above the available nil-rate bands. This includes all assets owned by the deceased at death, plus certain gifts made within seven years (failed PETs), and assets in certain trusts. The rate is 40%, or 36% if 10% or more of the net estate is left to charity.
When a donor dies within seven years of making a PET, the gift becomes chargeable. The nil-rate band is applied first to CLTs, then to failed PETs in chronological order. This can mean that gifts made years earlier suddenly create an IHT liability.
All chargeable lifetime transfers and failed PETs made within seven years of death are added together and count towards the available nil-rate band. Gifts made more than seven years before death are exempt. The seven years is measured from the date of the gift to the date of death.
Taper relief reduces the IHT on failed PETs depending on how long the donor survived after making the gift. The relief applies only to the tax on the gift, not the gift itself. Taper relief is only available if the gift would have been chargeable (i.e., after using the nil-rate band).
| Years survived | Tax percentage |
|---|---|
| 0-3 years | 40% (no relief) |
| 3-4 years | 32% (20% reduction) |
| 4-5 years | 24% (40% reduction) |
| 5-6 years | 16% (60% reduction) |
| 6-7 years | 8% (80% reduction) |
| 7+ years | 0% (gift exempt) |
The nil-rate band is the amount that can be transferred free of IHT. For 2025/26, this is £325,000. When calculating IHT on death, the NRB is applied first to chargeable lifetime transfers, then to the estate. Any unused NRB can be transferred to a surviving spouse or civil partner.
When the first spouse dies, any unused portion of their NRB can be transferred to the surviving spouse. This is claimed when the surviving spouse dies. The combined NRB can be up to £650,000. The transfer is automatic at 100% - the surviving spouse gets the full unused amount, not adjusted for inflation.
The RNRB applies when a residence is passed on death to direct descendants (children, grandchildren, stepchildren). The deceased must have lived in the property at some point. The RNRB is lost if the estate is worth over £2 million, tapering by £1 for every £2 over the threshold.
The nil-rate band is a lifetime cumulation of gifts. Each time a chargeable lifetime transfer is made, it uses part of the NRB. When the donor dies, any remaining NRB is available against the estate. If previous gifts exceeded the NRB, the excess is taxed at death with potential taper relief.
The residence nil-rate band has complex conditions including downsizing relief, residence requirement, and tapered withdrawal. Careful planning is needed to maximise RNRB entitlement, especially for blended families or where property value exceeds available allowances.
Transfers between spouses or civil partners are exempt from IHT, regardless of the amount. This includes gifts made during lifetime and transfers on death. The exemption applies only if both are domiciled in the UK, or if the recipient is domiciled in the UK and the gift is from a foreign-domiciled spouse.
Gifts to registered UK charities are exempt from IHT. This includes lifetime gifts and legacies in wills. Additionally, if at least 10% of the net estate is left to charity, the IHT rate on the entire estate is reduced from 40% to 36%.
Gifts to UK political parties are exempt from IHT, provided the party meets certain criteria including having at least two members elected to the House of Commons or one elected member plus at least 50,000 votes.
Payments for the maintenance of a former spouse or civil partner are exempt, provided they are reasonable and made under a court order or separation agreement. This includes regular payments and lump sums paid as maintenance.
Business Property Relief (BPR) reduces the value of business assets for IHT purposes. It can provide 100% or 50% relief, meaning these assets are either completely free of IHT or taxed at only half their value. BPR is available for sole traders, partnerships, and shares in unquoted companies.
Agricultural Property Relief (APR) reduces the value of agricultural property for IHT. Like BPR, it can provide 100% or 50% relief. It applies to farmland, farm buildings, farmhouses, and certain agricultural machinery. The relief aims to keep family farms intact across generations.
Other reliefs include woodlands relief (100% on timber, 50% on land), heritage property relief (in lieu of inheritance tax), and relief for certain works of art and other heritage assets that are made available to the public.
BPR at 100% applies to business assets, shares in unquoted companies, and controlling holdings in quoted companies. BPR at 50% applies to certain business assets including land, buildings, machinery, and equipment used in a business, and shareholdings of less than 50% in quoted companies.
Qualifying assets for 100% BPR include: a business carried on by a sole trader or partnership, shares in an unquoted company, or a controlling interest (more than 50%) in a quoted company. The business must be trading rather than investment-based.
To qualify for BPR, the asset must have been owned for at least two years before death (or the date of the gift). For replacement business assets, relief may still be available if the original asset qualified and was replaced. The two-year period can run after a business has ceased trading in some circumstances.
BPR is not available for businesses mainly dealing in securities, stocks or shares, land or buildings, or making or holding investments. These are investment businesses rather than trading businesses. Assets held purely for investment or rental purposes typically don't qualify.
Shares in unquoted companies generally qualify for 100% BPR. For quoted companies, only controlling holdings (more than 50% of voting rights) qualify. Some preference shares and loan stocks may also qualify if they are integral to the business.
BPR requires careful planning. The distinction between trading and investment businesses can be unclear. Mixed businesses may receive partial relief. Seek professional advice to maximise BPR entitlement and ensure proper business structure.
APR applies to the agricultural value of land and pasture - the value of the land as agricultural land rather than its market value, which may include development potential. Relief is based on what the land would fetch if sold for agricultural use only.
APR at 100% applies to agricultural land and pasture, including farm buildings, cottages for farm workers, and farmhouses occupied by the farmer. 50% APR applies to other agricultural property that doesn't meet the strict occupancy requirements for 100% relief.
To qualify for APR, the property must have been owned for at least two years before death (or gifted). For land occupied by a tenant, relief is only available if it was let on a tenancy beginning at least 7 years before the transfer. The farmer must also have occupied the land for farming purposes.
For farmhouse relief, the farmer must have occupied the house as a dwelling and the house must be character-appropriate (not too grand for the farming operation). The "character appropriate" test considers the size and nature of the house relative to the farming requirements.
APR and BPR can both apply to the same asset, but double relief is not given. Generally, the more favourable relief (typically BPR at 100%) is applied. Farm businesses may benefit from careful planning to maximise available reliefs.
Under the gift with reservation of benefit rules, if a person gives away property but continues to benefit from it, the property is still treated as part of their estate for IHT. Examples include giving away a house but continuing to live in it rent-free, or giving away a racehorse but continuing to enjoy its winnings.
The pre-owned assets tax (POAT) charges an income tax on assets where the donor gave them away but still benefits. This was introduced to counter schemes to avoid gifts with reservation. Affected assets are taxed at their rental value as income in the hands of the beneficiary.
Associated operations are a series of transactions that, viewed together, amount to a larger transaction. HMRC may look at the overall effect rather than individual transactions. This prevents people from achieving the same result as a taxable transaction through multiple smaller steps.
The settlements legislation applies IHT charges to certain trusts. Discretionary trusts and some interest in possession trusts incur periodic charges (every 10 years) and exit charges when property leaves the trust. These rules prevent accumulation of wealth in trust free of IHT.
HMRC actively challenges arrangements that are primarily tax-motivated. The Ramsay principle allows HMRC to disregard the form of transactions and look at substance. Any arrangement that lacks commercial substance other than tax savings is at risk.
IHT calculation involves: (1) Valuing all assets at date of death, (2) Adding any gifts within seven years (grossed up), (3) Deducting liabilities and funeral expenses, (4) Applying the nil-rate band and any transferred NRB, (5) Calculating tax at 40% (or 36% with 10% charity), (6) Applying taper relief where applicable.
When calculating IHT on failed PETs, the grossed-up value must be used. This means calculating what the gift would be worth including the tax that would be payable. The formula is: Gross value = Net gift × (100 ÷ (100 - tax rate)). This ensures tax is calculated on the full value.
Different reliefs interact in specific ways. The nil-rate band is applied first, then exemptions, then specific reliefs like BPR and APR. The order matters because some reliefs may not be needed if others have already eliminated the tax liability.
Example: Estate worth £500,000, £50,000 gift 3 years before death, nil-rate band £325,000. Total chargeable = £550,000. Taxable amount = £550,000 - £325,000 = £225,000. IHT = 40% × £225,000 = £90,000. Taper relief applies to £50,000 gift: tax reduced from £20,000 to £16,000.
| Step | Item | Calculation |
|---|---|---|
| 1 | Value of estate at death | Sum of all assets |
| 2 | Plus: Grossed-up lifetime gifts | Gifts within 7 years |
| 3 | Minus: Debts and expenses | Funeral, liabilities |
| 4 | Net estate value | Step 1 + 2 - 3 |
| 5 | Minus: Nil-rate band | -£325,000 (or more with transfer) |
| 6 | Taxable amount | Remaining value |
| 7 | IHT at 40% (or 36%) | Tax calculation |
| 8 | Minus: Taper relief | If applicable |
| 9 | Final IHT payable | Amount due |
IHT400 is the main inheritance tax account form. It must be completed for all estates that are not excepted estates. The form requires detailed information about assets, liabilities, lifetime gifts, exemptions, and reliefs claimed. Supporting documentation such as valuations must be provided.
IHT205 is a simplified form for excepted estates - smaller estates meeting certain criteria. It requires less detailed information than IHT400 and can be completed more quickly. It is available for estates below the IHT threshold plus additional allowances.
Inheritance tax must be paid within six months from the end of the month in which the death occurred. Interest is charged on late payments from the due date until payment is made. For property subject to instalment options, the six-month deadline applies to the first instalment.
Interest accrues on late IHT payments at the prevailing rate. For certain assets (mainly property and businesses), IHT can be paid in annual instalments over 10 years, with interest charged on the unpaid balance. The asset can be sold during this period to pay the outstanding tax.