How does inheritance and gift tax work in London and the UK

Inheritance and gift tax in the United Kingdom, often referred to as Inheritance Tax (IHT), is one of the most debated aspects of estate planning. It determines how much of an estate is passed on to beneficiaries and how much must be paid to HM Revenue & Customs (HMRC). The standard inheritance tax rate is 40%, but multiple exemptions, allowances, and planning strategies exist to reduce this burden significantly. Understanding the rules is crucial for families in London, where property prices drive estate values well above the tax-free thresholds. To navigate this complex system, beneficiaries and donors must know the allowances, rates, and available reliefs, as explained by The WP Times.

Basic principles of inheritance tax in the UK

Inheritance Tax applies to the value of an estate above the available tax-free allowances. The estate includes property, money, investments, and certain possessions. Unlike Germany, the UK system taxes the entire estate, not the share each beneficiary receives. The executor of the estate or personal representative is responsible for reporting to HMRC and paying any due tax before distributing assets.

Inheritance Tax may also apply to gifts made during a person’s lifetime if the donor dies within seven years of giving them away. This rule prevents people from avoiding tax by gifting assets shortly before death. Known as the “seven-year rule,” it creates a sliding scale of liability depending on the time elapsed since the gift was made.

Tax-free allowances in the UK

Main allowances:

• Nil-rate band: £325,000 per individual. Every estate has this basic threshold tax-free.
• Residence nil-rate band (RNRB): Up to £175,000 per person if a family home is passed to direct descendants (children, grandchildren).
• Spousal exemption: Unlimited transfers between spouses or civil partners are tax-free, regardless of value.
• Charity exemption: Gifts to registered charities are exempt. If 10% or more of the estate is left to charity, the overall IHT rate can drop from 40% to 36%.

Combined, a married couple can potentially pass up to £1 million tax-free if they include the residence nil-rate band when leaving their home to children.

Rates and liability

In London, where average house prices exceed £550,000, many families cross the nil-rate threshold, making estate planning essential.

Gifts and the seven-year rule

Types of gifts:

• Annual exemption: Up to £3,000 per year per person can be gifted tax-free.
• Small gift exemption: Up to £250 per person per year.
• Wedding gifts: Up to £5,000 for children, £2,500 for grandchildren, £1,000 for others.
• Potentially Exempt Transfers (PETs): Larger gifts are tax-free if the donor survives 7 years. If death occurs within 7 years, tax applies on a tapered scale:

Exemptions and reliefs

1. Business Relief – Up to 100% relief for qualifying businesses, shares in unlisted companies, and certain agricultural property.
2. Agricultural Relief – Up to 100% relief on farmland and related assets if farming continues.
3. Charity and political donations – Fully exempt, reducing taxable estate.
4. Pensions – Most defined contribution pensions are exempt if the policyholder dies before age 75.

These reliefs make the UK system flexible for entrepreneurs, farmers, and high-net-worth individuals.

Filing and deadlines

Inheritance Tax must usually be paid within six months of the person’s death. The executor is responsible for filing an IHT400 form with HMRC and arranging payment. If the estate includes property, tax can sometimes be paid in installments over 10 years.

Key steps for executors in London:

1. Notify HMRC and submit the IHT return.
2. Apply for probate only after tax is paid or arrangements are made.
3. Pay from estate assets (bank accounts, investments) or through HMRC’s Direct Payment Scheme.
4. If property must be sold, HMRC may accept staged payments until sale completion.

Late payments lead to interest charges and potential penalties.

Practical examples

• Married couple in London with £900,000 home + £100,000 savings: With combined nil-rate band (£650,000) + RNRB (£350,000), the entire estate passes tax-free to children.
• Single homeowner with £600,000 flat in London: Allowance £325,000. Taxable £275,000 at 40% = £110,000 tax.
• Grandparent giving £400,000 to grandchild as a gift: PET applies. If donor dies 8 years later, no tax. If within 3 years, £400,000 – £325,000 = £75,000 taxable at 40% = £30,000 tax.

Tips for reducing inheritance tax in London

• Use annual gifting allowances proactively.
• Transfer wealth early to take advantage of the seven-year rule.
• Set up trusts for flexible distribution and tax efficiency.
• Leave at least 10% to charity to reduce overall tax rate.
• Review property ownership and use residence nil-rate band.
• Seek professional advice to combine business or agricultural relief with personal allowances.

Inheritance and gift tax in London and the wider UK remains a critical issue, especially with rising property values pushing more estates over the tax threshold. While the 40% rate seems daunting, strategic planning, smart use of allowances, and lifetime gifting can drastically reduce the liability. Families that prepare early can pass on significantly more wealth, protect their property, and avoid burdening heirs with unexpected tax bills. Professional guidance is especially valuable in London, where high-value estates face the greatest exposure.

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