Inheritance tax, also known as estate tax, is a tax levied on the estate of a deceased person. It is paid by the beneficiaries of the estate to the government. If you want to maximise the amount of your estate that goes to your loved ones, you may be interested in exploring the below ways to minimise or avoid inheritance tax.
Considering how to avoid inheritance tax on a property should be considered an important part of estate planning as it will be out of your control once you pass away so it is important to make changes while you’re alive.
Plan for your funeral expenses by purchasing a funeral plan
Often, inheritance tax can be avoided by paying for more of the funeral expenses upfront before you die. This includes taking out a funeral plan. This would prevent your loved ones from having to collect the estate you have left behind, pay taxes on it and then pay for funeral expenses.
Instead, you can avoid tax by paying for funeral expenses before you die so you can perhaps reduce the amount you leave behind and maybe keep it under the threshold of paying inheritance tax of £325,000.
This can be especially important if you know you want to spend a large amount on a funeral and allows you to customise the funeral you want to have before you die which is a nice touch for your own peace of mind and so your family knows what plans you have in place after you pass away.
Protect your loved ones with a life insurance policy
Life insurance policies are perfect for those who want to insure against their tax bill. The only bad thing about this is if you are likely to die relatively soon due to old age or a diagnosis of a terminal illness, your premium is likely to go up a lot. Life insurance only tends to be worth it if you take it out at an early age when you’re young and healthy.
In order to benefit from this, the policy must involve clauses to make sure the funds paid into the policy are given to the family members of the deceased once they pass away. In this way, any money paid into life insurance will be exempt from inheritance tax and depending on the policy, there may be extra clauses that help the family of the deceased pay for additional expenses like a funeral for example.
Use available allowances to reduce the tax on your property
Planning ahead for what part of your estate falls into the threshold of being taxed at a 40% inheritance tax can be a great way to avoid inheritance on a property altogether.
For example, if someone who wants to make sure their estate is passed down to their kids has a £350,000 estate valuation. They may want to get rid of £25,000 before they die. There are a variety of ways to get rid of additional income such as giving to charity, putting money in a trust or simply just spending it.
Whatever the reason is, making a note of this £325,000 figure is essential as anything over it will be taxed heavily and it is relatively easy to predict how much you will leave behind above this figure. You may have to hire someone to properly evaluate your estate before making any big decisions.
Transfer agricultural land or buildings to minimise inheritance tax
Transfers are taxed differently from inheritances. Because of this, it is vital you take advantage of this to avoid inheritance tax on property or at least not pay as much. The law in this area specifically applies to those transferring agricultural land and buildings.
While you may need to take advice from a solicitor in order to do so, you may be able to convert a residential property into an agricultural one so you can take advantage of agricultural property transfers that are free of inheritance tax.
Agricultural property that qualifies for this scheme must have land or pasture that is used for the growing of crops or the rearing of animals. This can include:
- Cultivating crops
- Horse breeding and raising facilities
- Fast-growing trees that are cut and replanted every 10 years
- Land not used for farming under a habitat conservation plan
- Land not used for crop rotation
- The value of the milk production quota associated with the land
- Agricultural stocks and securities
- Farm structures, including cottages and houses
While it is recommended to check this over with a professional who knows the law in this area in detail, you will not be able to avoid inheritance tax on any of these items:
- Farm equipment and machinery used on a farm to plant, grow, and harvest crops
- Derelict buildings that are abandoned or neglected structures but used to be agricultural
- Harvested crops that have been grown and already sold
- Livestock alive or dead raised for food
- Property that has been agreed to be sold but is awaiting finalisation
Furthermore, the property has to be part of a working farm in the UK, Channel Islands, Isle of Man or a European Economic Area. Also, the property has to have been used for the growing of crops and rearing animals for at least two years or seven years if the property was occupied by someone else and you recently bought it. For more on the exact regulations, see the government website here.
Use your inheritance as you wish, rather than leaving it to be taxed
Depending on someone’s beliefs and what their goals are for when they will pass away, it may be that they don’t care about what happens to their estate after they die. In cases like this, you could use the inheritance as you wish without it needing to be taxed.
When learning how to avoid inheritance tax on a property in this way, doesn’t necessarily mean you have to get rid of the property either. This is because you can get rid of the other parts of an estate that will bring the inheritance above the taxable threshold.
As an example, if someone has £500,000 in total, they may have some of their assets in the bank, some in other assets outside of real estate industry and some in general belongings. If you want to keep the property under the tax threshold of £325,000, you could get rid of the other parts of the estate outside the property.
Avoid inheritance tax on property by giving it away before you die
Gifts are a way you can transfer the equity in a property to a family member by making them the legal owner of a property. They will be shown on the land registry and will be completely responsible for the property.
Pending on the relation of the person that is being given to the gifter and how much in value the gifter has already given way in the tax year and in what context are all variables for how much you will be taxed. For the regulations on these tax rates, see the government website here.
What is the small gift exemption?
In Ireland, part of the UK, there are similar rules to the gift exemptions in the rest of the UK except they are called something slightly different – small gifts.
By using small gifts, you are able to receive a tax-free gift from any person in a calendar year as long as the value of the gift is €3,000 or less. In the same way, this can only be done while someone is alive and they are not associated with inheritances, just ways to transfer
Take advantage of exemptions for business owners
Business tax exemptions are available with Business Property Relief (BPR). This is the main tax relief that applies to inheritance tax for business owners. The way this is applied is by reducing the amount of Inheritance Tax (IHT) that is due on a business or farm. In order to qualify for BPR, the business or farm must meet certain criteria, such as being a trading business or being used for the purpose of a trade, profession, or vocation.
When BPR is applied, the value of the business or farm is deducted from the taxable value of the deceased’s estate, which can significantly reduce the amount of IHT that is due. For example, if the value of the business or farm is £500,000 and the taxable value of the estate is £1 million, BPR would reduce the amount of IHT due by £500,000.
In order to claim BPR, the executor of the deceased’s estate must make a claim to HM Revenue and Customs (HMRC) within two years of the date of death. It is important to note that business property relief is not an automatic process and must be claimed in order to be applied.
Explore equity release as a way to access the value of your property without selling it
Releasing equity from a property is a smart way to stop money in a property being subject to inheritance tax. In order to do this, you can take out a home equity loan or another mortgage to remortgage your home.
If the property has gone up in value, you should be able to get a larger mortgage that pays off the smaller mortgage, leaving you with some equity in between.
The funds can then be given away to whatever cause you desire before you pass away so you don’t have to include them as part of your estate when you die and subject it to tax.
Having said this, you would have to consider this carefully as sometimes it doesn’t make sense to pull equity out of a home and you are better off leaving this to the person who inherits the property to do as they may be able to benefit from more capital appreciation over time and not pay as much capital gains tax anyway. This is explained in the below heading.
Sell assets that are not subject to Capital Gains Tax
If you are a savvy investor, you may be able to benefit from economic changes and sell a property in the worst periods of the economy to a family member. For example, if you sell a property when it has appreciated in a good economy, you will have to pay more tax than usual.
Therefore, it may be wise to only pass down assets that aren’t able to be taxed by capital gains because they are in a period of capital depreciation. If you have a property in your estate that you realise is dipping in value. This could be a good time to sell it to someone you love.
As a result, the family member who would have bought the property could hold the property over a time period of years to decades to gain back the capital appreciation that has dipped. If this is done right, they would have gained ownership of a property on the landlord registry without the original seller who may be deceased having paid any capital gains tax.
Create a will to specify how you want your assets distributed
To create a will, you will need to follow several steps to craft the will with all the right details. Firstly, you should determine what your assets are. Then, you should make a list of all of your assets, including your property, bank accounts, investments, and personal belongings.
When your assets are clear, you must select a trusted individual who will be responsible for carrying out the terms of your will. This can be an executor or a family member. As you do this you can date the will and figure out where you will store the will safely such as in a deposit box or with an attorney. Let your executor know where to find it.
Finally, the most important part of the will include who the beneficiaries are and what assets you want to give them. To make this process easier you can use a will-writing service or a template to create a legally bringing document.
It is also a good idea to review and update your will regularly, especially if you have experienced significant life changes such as the birth of a child, the death of a beneficiary, or a change in your financial situation. However, if you don’t do this it is not the worst thing as a deed of variation can be made after someone passes away to change the features of the will.
Keep your estate below the inheritance tax threshold
One of the simplest ways on this list of how to avoid inheritance tax on a property is to simply make sure the value of the estate is less than the threshold of £325,000. Anything more than this threshold will be charged at a rate of £325,000 per year at 40%.
Actively not trying to invest to make more money and potentially giving away any more money that is over the threshold in your estate could be ways solutions when figuring out how to avoid paying inheritance tax on a property. In addition, if you have a significant amount of money available, it may be the case that you have to set up a trust in order to keep the money safe from taxes.
Give money to family members and friends as gifts
Gifts are one of the easiest ways to avoid inheritance tax as you can give away a certain amount tax-free before you die. Depending on how soon after you die, the gifts may or may not be subject to inheritance tax. Read our article on inheritance tax on a property for more on how this works.
In general, no tax is due on a gift if it was seven years before the date of death that the gift was given away. Unless the gift is part of a trust. Other than this, gifts will be charged tax in incremental amounts, with more tax needing to be paid if the gift was given very close to the gift giver’s death. There are exemptions if the gift was given as part of a trust.
Donate money to charity to reduce the size of your taxable estate
Charity donations are an easy way to make sure you are under the inheritance tax threshold. For example, if you are able to give away anything above the value of £325,000 in your estate to the relevant people, you will end up having to pay no tax.
This is a nice way to reduce your inheritance tax bill, especially if you favour a charitable cause you are passionate about rather than giving the money to the government in the form of tax.
Use wedding gifts as a way to give money to loved ones without incurring taxes
Wedding gifts are usually quite expensive so you can use big occasions like this to give money away if you know the person getting married will be on your will anyway. You can give up to £5,000 tax-free as part of a wedding gift and up to £3,000 tax-free.
The great thing is this kind of gift is separated from the tax allowances of any other type of gift such as the £3,000 which you can use annually for tax free gifts under the small gifts allowance.
Place your assets in a trust to manage them and potentially reduce inheritance tax
Trusts can be completely exempt from inheritance tax if you set them up in the right way making them an excellent answer on how to avoid inheritance tax on a property. The first thing you should do is choose a trust type. This can be a bare trust or an Interest in Possession Trust, Discretionary trust, Accumulation and Maintenance Trust or a Mixed Trust.
Because of the complexities involved, you may need to rely on a solicitor or legal professional to help you set up the legal documents to make sure the trust fund is able to be set up in the correct manner
Use a deed of variation to change the distribution of your estate after your death
A deed of variation is a document used by the beneficiary and the deceased in case there are any changes the beneficiary wants to make to the will.
This process can be done by a deed of variation solicitor who will make changes to the will of the deceased on the beneficiary’s behalf. Often, these changes are there to make sure the beneficiary doesn’t pay excessive amounts of tax or because they want to move assets into someone else’s name who is also in need of inheritance.
For example, it would be typical for a deed of variation to be used if only one child was written on the will and there were additional children born after the will was written. The child that was written in the will can then add other children to the will to distribute assets more evenly and potentially save on tax.
In conclusion, there are several ways to avoid inheritance tax on a property. By making a will, setting up a trust, and giving gifts to loved ones, you can reduce the amount of tax that will be owed on your property when you pass away.
Additionally, considering the use of exemptions and reliefs can also help to reduce the amount of inheritance tax that will be due. By taking these steps, you can help to ensure that your loved ones receive the full value of your property, without having to pay a large amount of inheritance tax.