How Do I Plan for Inheritance Tax on Property

Introduction

Inheritance Tax is charged on the value of your estate when you die, including property, money, and personal possessions. The standard rate is 40 percent on assets above the tax-free threshold, known as the nil rate band.

Because property values have risen over the years, many families now find themselves above the threshold without realising it. Proactive planning helps ensure more of your wealth passes to your loved ones rather than to the taxman.

How Inheritance Tax on property works

When you die, HMRC calculates Inheritance Tax based on the total value of your estate. This includes:

Your home and any other property you own.

Cash, savings, and investments.

Business or farm assets.

Personal possessions such as cars, jewellery, and furniture.

If the total value exceeds your tax-free allowances, your estate may pay IHT at 40 percent on the excess.

The main allowances

Nil rate band (NRB): £325,000 per person. This can be transferred to a spouse or civil partner, allowing couples to pass on up to £650,000 tax free.

Residence nil rate band (RNRB): An extra £175,000 per person when passing your main home to direct descendants such as children or grandchildren. Together, a couple could potentially pass on up to £1 million tax free if their estate qualifies.

If your estate is worth more than £2 million, the RNRB is reduced by £1 for every £2 over this threshold.

1. Leave property to your spouse or civil partner

Gifts to a spouse or civil partner are completely exempt from Inheritance Tax, regardless of value. When the surviving partner dies, their estate can use any unused nil rate band from the first partner’s estate, doubling the available threshold.

Example

If you leave everything to your spouse, no tax is due on your death. When your spouse later passes away, their estate can use both £325,000 allowances, meaning up to £650,000 can pass on tax free.

If your home also qualifies for the residence nil rate band, this amount can rise to £1 million for a couple.

2. Use the residence nil rate band

The residence nil rate band is designed to help families pass on their main home without paying excessive IHT. To qualify:

The property must be your main residence.

It must be left to direct descendants (children, grandchildren, stepchildren, or adopted children).

The total estate must be under £2 million to receive the full allowance.

If you own more than one property, your executors can choose which one applies for the relief.

3. Gift property during your lifetime

Gifting your property or a share of it while you are alive can reduce your estate’s value for IHT, but there are important conditions to consider.

If you gift property and survive for seven years, the value of the gift is completely exempt from Inheritance Tax under the seven-year rule. If you die within seven years, tax may still apply, though taper relief can reduce the amount owed.

However, if you continue to live in the property after gifting it without paying full market rent, HMRC will classify it as a gift with reservation of benefit, meaning it remains part of your estate for IHT purposes.

Example

If you gift your home to your children but continue living there rent free, it is not removed from your estate. Paying full market rent to your children can make the gift effective for IHT, but the rent payments themselves may be subject to Income Tax for them.

4. Consider downsizing or equity release

If your home is larger than you need, downsizing can help reduce the size of your taxable estate while freeing up cash to gift to family members.

HMRC allows you to retain the residence nil rate band even if you sell your home and move to a smaller property, as long as assets of equivalent value are left to your direct descendants.

Equity release schemes can also help you access funds to gift or spend during your lifetime, though these arrangements should be considered carefully due to potential impacts on your estate value and future financial stability.

5. Use trusts for long-term planning

Placing property into a trust can help manage Inheritance Tax and control how assets are distributed. For example:

Discretionary trusts allow flexibility over who receives property and when.

Life interest trusts can allow a surviving spouse to live in a property for life, with ownership passing to children after their death.

Be aware that transferring property into a trust can trigger an immediate IHT charge if the value exceeds your nil rate band and may also have implications for Capital Gains Tax and ongoing trust taxes. Professional advice is strongly recommended before setting up a trust.

6. Use your annual gift exemptions

Each year, you can give away up to £3,000 tax free under the annual exemption. You can also make small gifts of up to £250 to any number of people and wedding gifts of up to £5,000 to a child.

While these smaller gifts may not immediately impact large property values, they can help reduce the overall size of your estate over time.

7. Leave part of your estate to charity

If you leave at least 10 percent of your net estate to charity, the Inheritance Tax rate on the remaining portion of your estate is reduced from 40 percent to 36 percent.

This can be a valuable strategy if you already intend to make charitable donations while also reducing the tax burden for your beneficiaries.

8. Take out life insurance

A life insurance policy written in trust can provide funds to cover the potential IHT bill without increasing the taxable estate. This ensures your beneficiaries can pay the tax due without needing to sell property quickly.

Premiums are typically small compared to the potential tax liability, making it a useful planning tool for those with valuable estates.

9. Keep your will up to date

An outdated will can cause unnecessary tax complications. Review your will regularly to ensure your property is distributed in the most tax-efficient way and reflects your current wishes.

Professional estate planning advice can help you structure your will to take advantage of available allowances and ensure your beneficiaries receive the maximum benefit.

Example scenario

John and Mary own a home worth £700,000 and savings of £200,000. They leave everything to each other on the first death and then to their two children.

When the second spouse dies, the estate is worth £900,000. Using both nil rate bands (£650,000) and two residence nil rate bands (£350,000 combined), the total allowance is £1 million, meaning no Inheritance Tax is due.

Without the residence nil rate band, the estate would have exceeded the threshold, resulting in a £100,000 IHT bill at 40 percent.

Common mistakes to avoid

Gifting property but continuing to live in it without paying rent.

Failing to use available allowances such as the residence nil rate band.

Leaving property to non-direct descendants and losing valuable relief.

Not reviewing your estate plan as property values change.

Assuming property transfers to family members are automatically tax free.

Conclusion

Planning for Inheritance Tax on property is essential if you want to protect your family’s wealth. Making use of available allowances, gifting property strategically, and keeping your will and records up to date can reduce or even eliminate the tax due on your estate.

Because property planning often involves complex tax rules, it is sensible to seek advice from a qualified tax adviser or solicitor. With careful preparation, you can ensure your property passes smoothly to your loved ones with minimal tax impact.