What is the 7-year rule in Inheritance Tax?
The 7-year rule in inheritance tax means that when you give a ”gift” to someone, there is no tax to be paid if you live for 7 years after giving them that “gift” (unless the gift is part of a trust).
However, if you die within 7 years of giving the “gift,” there will be Inheritance Tax (IHT) to pay which is calculated on a sliding scale known as “taper relief”.
This does not include gifts to spouses or civil partners if they live permanently in the UK or if you want to gift something to a political party or charity.
What is taper relief?
Gifts that are given in the 3 years before your death are taxed at 40%. Those given between 3-7 years before death are taxed on a sliding scale (taper relief). For example:
- 3-4 years - 32% tax
- 4-5 years - 24% tax
- 5-6 years - 16% tax
- 6-7 years - 8% tax
- Over 7 years - nil-rate tax
What is a “gift” in legal terms?
A gift can include money, household and personal goods such as furniture, jewellery, or antiques; a house, land, or buildings as well as stocks and shares that are listed on the London Stock Exchange.
Anything left in a will does not count as a gift because it is part of your estate which is all your money, savings, property, and possessions when you die. The value of your estate is however used to work out if Inheritance Tax needs to be paid.
Do I have to pay inheritance tax on my parents’ home?
Yes, you would normally pay IHT on your parents’ home if their home is worth more than £350,000 because IHT is paid on anything above the value of the nil-rate band which for the 2022/ 23 tax year is set at £350,000.
If the estate is valued at more than this threshold, the IHT is 40%.
The good news is that from April 2017 an extra allowance called the Residence Nil-rate Band was introduced and takes £175,000 out of the value of the estate for the 2022/23 tax year and will remain in place until 2025/26.
In reality, this means that an individual estate has an IHT of £500,000 before any tax needs to be paid. You must remember though that this only applies to one home in the estate and it must be where the person lived in the UK.
How do I legally avoid inheritance tax on my parents’ house?
You may not necessarily be able to avoid inheritance tax in some cases, but there are ways that you can reduce the burden of IHT.
There are several ways of reducing the burden of IHT by managing your estate in an effective and efficient manner.
Make a Will
It is imperative that you make a Will and avoid all the headaches associated with the rigid rules of intestacy and delaying the deceased’s affairs.
Give assets away
As well as giving assets away under the 7-year rule and avoiding tax, you can also give gifts totaling £3000 each year which will be completely free of IHT. In addition to this, you can gift £5000 on the occasion of a child’s wedding.
Put assets into a trust
You can avoid IHT by setting up and placing assets into a trust for the benefit of your children when they reach the age of 18 years old. Any assets in a trust will not form part of your estate on death and therefore avoid IHT.
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