For most of us, a house will be the most valuable asset we ever own. So it makes sense that you would want to pass it on to your offspring, and to ensure they get the most out of owning it. But with the inheritance tax threshold – or “nil rate band” – currently frozen while house values remain high, it’s a good idea to work out whether your descendants are going to be left with a major tax bill when you leave them property.
How does inheritance tax on homes work?
There are a few instances in which your heirs may have to pay additional tax on a property once it’s inherited, depending on what they choose to do with it. You might want to discuss this with them before leaving the home to them, to ensure they know what to expect. If they decide to sell the property without living in it, they will likely need to pay capital gains tax (CGT). This is a levy applied to profits made on the sale of an asset. While there is an exemption for people selling their own home, a house you’ve bequeathed to your descendants will usually be classed as a second home if they choose not to move into it.
Capital gains tax is calculated according to profit made from selling an asset. When it comes to inheritance, the amount of profit is determined by the value of the house at the time the original owner dies. If the price has remained the same by the time it is then sold, there will be no profit to tax. But if it has increased, the new owner or owners will have to pay normal CGT rates.
Other tax considerations also arise if your family choose to rent your house out after you die. This can be a great way for them to make additional income, especially if they would prefer not to sell it. But they will probably need to pay income tax on the proceeds, as well as the normal costs any landlord can expect such as agency fees, licences and insurance.
Can I gift property to my kids before I die?
One way of ensuring your children or other descendants won’t have to pay inheritance tax is to pass the property on to them while you are still alive. But this is not always straightforward, in part because of something known as the “seven-year rule”.
This rule dictates that no inheritance tax is due on gifts if you live for seven years after giving them. If you do die within three years of giving them, the gifts could be liable for the full inheritance tax rate of 40 per cent. If you die between three and seven years after making the gift, then it can be taxed on a sliding scale.
So that means if you give away your property to a family member, but then die within the next seven years, they may still be liable to pay inheritance tax on the house – if its value exceeds the nil rate band. On receiving the gift, the new owner will also have to pay stamp duty if there’s still a mortgage on the property. If there’s no mortgage, then no stamp duty is due.
