How Is Inheritance Tax Calculated in the UK

Introduction

When someone dies, everything they own—such as property, savings, and possessions—forms their estate. The executor or personal representative must value the estate, subtract any debts and exemptions, and then calculate whether Inheritance Tax is payable.

Inheritance Tax is currently charged at 40 percent on the value of the estate above certain tax-free allowances. However, with careful planning, most families can reduce or avoid it altogether.

Step 1: Work out the total value of the estate

The first step in calculating Inheritance Tax is to value everything the person owned at the date of death. This includes:

Property, such as their home or other real estate.

Cash and savings.

Investments, including shares and bonds.

Personal belongings such as jewellery, vehicles, or art.

Business assets and life insurance (if not written in trust).

The total value of these assets forms the gross estate. Any outstanding debts, such as mortgages, credit cards, or funeral expenses, are then deducted to find the net estate value.

Step 2: Apply the tax-free allowances

The nil rate band

Every individual has a nil rate band of £325,000. This means the first £325,000 of their estate is not subject to Inheritance Tax.

If the total value of the estate is below £325,000, no tax is payable. If it exceeds this, tax is only applied to the amount above that threshold.

The residence nil rate band

If the person owned a home that is left to their children or grandchildren, their estate may also qualify for the residence nil rate band, currently worth up to £175,000.

This means that, in some cases, individuals can pass on up to £500,000 tax free (£325,000 + £175,000). For married couples or civil partners, these allowances can be combined, allowing up to £1 million to be passed on tax free.

To qualify for the residence nil rate band:

The home must be left to a direct descendant (such as a child, stepchild, or grandchild).

The total estate value must be below £2 million. Above this, the relief tapers off by £1 for every £2 over the £2 million limit.

Step 3: Apply exemptions and reliefs

Spouse or civil partner exemption

Anything left to a surviving spouse or civil partner is completely exempt from Inheritance Tax, provided both partners are permanently resident in the UK.

In addition, any unused portion of the nil rate band or residence nil rate band can be transferred to the surviving spouse, potentially doubling the available allowances for the second death.

Charitable donations

Gifts to registered charities are exempt from Inheritance Tax. If at least 10 percent of the net estate is left to charity, the tax rate on the rest of the estate is reduced from 40 percent to 36 percent.

Business and agricultural relief

If the deceased owned a business or agricultural property, some or all of its value may qualify for Business Property Relief or Agricultural Property Relief, which can reduce the taxable value by up to 100 percent.

Gifts and the seven-year rule

Gifts made within seven years of death may also be included in the estate. These are known as potentially exempt transfers (PETs). If the person survives for seven years after making the gift, it becomes fully exempt.

If they die within seven years, taper relief may reduce the tax due depending on how long ago the gift was made.

Step 4: Calculate the taxable amount

Once allowances, exemptions, and reliefs have been applied, the remaining portion of the estate is the taxable estate.

The standard rate of Inheritance Tax is 40 percent on the taxable amount.

Example

Emma dies leaving an estate worth £600,000. She has not made any large gifts and is single.

Nil rate band: £325,000

Taxable estate: £600,000 £325,000 = £275,000

Inheritance Tax due: £275,000 × 40 percent = £110,000

If Emma left her home to her children, she would also qualify for the £175,000 residence nil rate band, increasing her total allowance to £500,000. In that case, tax would only apply to £100,000, resulting in a tax bill of £40,000.

Step 5: Work out who pays the tax

The executor or personal representative of the estate is responsible for ensuring Inheritance Tax is paid. They must submit the necessary forms to HMRC, typically IHT400 for taxable estates or IHT205 for smaller ones.

The tax is usually due within six months of the person’s death. If it is not paid by then, HMRC may charge interest.

If the estate includes property, HMRC allows the tax to be paid in instalments over ten years, provided interest is paid on the outstanding balance.

Step 6: Consider lifetime gifts and trusts

Lifetime planning can greatly reduce the eventual Inheritance Tax bill. This includes:

Using the annual gift exemption of £3,000 per year.

Making regular gifts out of surplus income.

Placing assets into trusts, which can remove them from your estate if managed correctly.

However, trusts can be subject to their own tax rules, so professional advice is recommended before setting one up.

Example calculation for a couple

John and Mary own a home worth £700,000 and have savings of £300,000, giving a combined estate of £1 million. When John dies, he leaves everything to Mary, which is exempt from Inheritance Tax.

When Mary later dies, the combined nil rate band (£325,000 × 2) and residence nil rate band (£175,000 × 2) mean up to £1 million can be passed to their children tax free. As their estate is worth exactly £1 million, no Inheritance Tax is due.

Common mistakes to avoid

Forgetting to include the value of lifetime gifts made within seven years.

Assuming all property automatically qualifies for the residence nil rate band.

Not transferring unused allowances from a late spouse or civil partner.

Missing out on charitable or business reliefs.

Leaving incomplete records or valuations, which can delay probate.

Conclusion

Inheritance Tax in the UK is calculated by valuing the estate, applying allowances and exemptions, and taxing the remaining balance at 40 percent. Most estates will not pay tax if proper planning is in place, as the combination of nil rate bands and spouse transfers can cover significant amounts.

By understanding how IHT is calculated and taking advantage of available reliefs, you can ensure more of your wealth passes to your loved ones rather than to the taxman. For complex estates or large gifts, professional advice from an accountant or solicitor is invaluable in making sure everything is handled correctly and efficiently.