Inheritance tax warning as gifts made years before death could lose a third to tax

Inheritance tax explained by Interactive Investor expert

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Inheritance tax (IHT) often encompasses any financial gifts made up to seven years before an individual dies, with some exemptions. However, giving these gifts strategically and utilising certain allowances can see some gifts being entirely tax-free no matter their value, so how does inheritance tax work on gifts?

Gifts in terms of IHT refers to anything given away that is not in one’s will as all items and value in a will is part of one’s estate.

Because of this, calculating IHT on one’s estate is usually more straightforward as gifts can include any of the following:

  • Money
  • Household goods
  • Land, house or buildings
  • Stocks and shares on the LSE
  • Unlisted shares held for less than two years before death

Gifts also include any money lost when selling something for less than its market value, for example if one sells their house to their children for less than it is worth the difference will count as a gift.

The IHT due for gifts is usually paid by the deceased’s estate unless they have given away over £325,000 worth of gifts in the seven years before their death.

Once this threshold has been passed, those that receive a gift in the seven years will need to pay IHT.

IHT can be applicable to gifts given long before the individual died and the amount of tax due depends on just what the gift was, who it was given to and when it was made.

In essence, gifts made over seven years before an individual dies are usually tax-free while those made within this time have different tax rates:

  • Gifts made three to four years before death: 32 percent IHT
  • Gifts made four to five years before death: 24 percent IHT
  • Gifts made five to six years before death: 16 percent IHT
  • Gifts made six to seven years before death: eight percent IHT
  • Gifts made more than seven years before death: zero percent IHT

Exemptions

The gifts that are exempt from IHT are those made to:

  • Spouses or civil partners as long as they live in the UK permanently
  • Charities
  • Political parties

Allowances

Every tax year has a certain allowance for gifts that can be made tax free.

The annual exemption allows one to give away £3,000 worth of gifts which can be split between several people.

Any unused annual exemption can be carried forward into the next tax year only once.

Small gift allowances provide for gifts up to £250 per person to be tax-free so long as another allowance hasn’t been used on the same person.

Birthdays and Christmas gifts provided from one’s regular income are also exempt from IHT.

Gifts for weddings or civil partnerships can also be tax-free but there are some limitations depending on one’s relationship to the party getting married.

Benefiting from gifts

Known as a “gift with reservation”, these gifts will count towards the value of one’s estate and includes things such as:

  • Giving a home to a relative but still living there
  • Giving away a caravan but using it for free for holidays
  • Giving away a painting but still displaying it in one’s own residence

By utilising a combination of benefiting from gifts, allowances and exemptions it could be possible to avoid a large IHT bill both for one’s estate and anyone they may have gifted during the last seven years of their life.

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