Inheritance Tax on lifetime transfers and transfers on death...

Learning Outcomes

This article outlines Inheritance Tax on transfers on death, including:

• Scope of IHT on transfers on death and assets included in the taxable death estate, including deemed interests (e.g. qualifying interests in possession and gifts with reservation)
• Estate valuation at open market value, deductible liabilities, and tax apportionment using the estate rate
• Nil rate band and residence nil rate band, including their transferability between spouses/civil partners and tapering of the RNRB for estates over £2 million
• Main exemptions (spouse/civil partner, charity) and reliefs (business property relief and agricultural property relief), including core qualifying conditions and common traps
• Effects of lifetime transfers within seven years of death, including PETs and CLTs, cumulation, taper relief on death charges, and credit for lifetime IHT already paid on CLTs
• Order for applying exemptions, reliefs and nil rate bands, and the charity 36% rate where applicable
• Liability to account for IHT and burden of the tax, payment due dates, and availability of the instalment option
• Post-mortem reliefs (shares, land) and quick succession relief, and circumstances in which they reduce the IHT ultimately payable
• Common pitfalls (e.g. applying annual exemptions to death estates, misapplying RNRB conditions, overlooking gifts with reservation)

SQE1 Syllabus

For SQE1, you are required to understand Inheritance Tax on transfers on death, with a focus on the following syllabus points:

• the definition and composition of the death estate for IHT purposes, including deemed interests (qualifying interests in possession) and gifts with reservation
• valuation principles and allowable liabilities; use of estate rate for apportionment
• the calculation and application of the nil rate band and residence nil rate band, including transferability and tapering for estates exceeding £2 million, and downsizing provisions
• the main exemptions and reliefs on death (spouse/civil partner, charity, business property relief, agricultural property relief), including qualifying conditions and clawback risks
• the order of applying exemptions, reliefs, NRB and RNRB; effect of leaving 10% or more to charity (36% rate)
• the effect of lifetime transfers within seven years of death on IHT due at death (cumulation, taper relief, credit for lifetime tax paid on CLTs)
• statutory rules for liability and burden of IHT; payment deadlines and the instalment option; the role of personal representatives and trustees
• recognition of post-mortem reliefs (quoted shares, land) and quick succession relief

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which assets are included in a person's estate for IHT purposes on death?
2. What is the nil rate band, and how does the residence nil rate band interact with it?
3. Name two main exemptions and two main reliefs that can reduce IHT on death.
4. Who is primarily liable to pay IHT on a death estate?

Introduction

Inheritance Tax (IHT) is charged on the value of a person’s estate at death, subject to specific exemptions and reliefs. For SQE1, you must be able to identify which assets are included in the estate, apply the nil rate band and residence nil rate band, and recognise when exemptions and reliefs reduce or eliminate the tax due. You should also understand the process for valuing assets, deducting liabilities, and calculating the final IHT bill.

The UK IHT regime is cumulative and looks back seven years from death to identify lifetime transfers that affect the nil rate band available at death. Some assets are included by statutory deeming rules even if the deceased did not own them outright immediately before death (e.g. certain trust interests and gifts with reservation). Death rate IHT is generally charged at 40% on amounts above the applicable nil rate bands, with a reduced 36% rate where the 10% charity threshold is met.

The Death Estate for IHT

On death, IHT is charged on the value of the deceased’s estate immediately before death. The estate includes all property to which the deceased was beneficially entitled, except for certain excluded property.

Key Term: death estate
The total value of all assets to which the deceased was beneficially entitled immediately before death, less allowable liabilities.

Assets included in the death estate typically comprise:

• land and buildings (freehold and leasehold)
• personal possessions (e.g. jewellery, vehicles, artwork)
• bank accounts, investments, and shares
• business interests
• life insurance policies payable to the estate
• certain trust interests (e.g. qualifying interests in possession)
• jointly owned property (the deceased’s share)
• gifts with reservation of benefit and some lifetime transfers within seven years

By statute, some property is treated as part of the death estate even though it does not pass under the will or on intestacy. Two key categories are:

• Qualifying interests in possession in settled property (e.g. an immediate post-death interest under a will): the trust capital is aggregated with the life tenant’s estate on death and IHT attributable to it is paid by the trustees.
• Gifts with reservation of benefit: where the donor continued to benefit from the gifted asset (e.g. continued occupation of a house given away), the asset’s full value at death is treated as part of the donor’s estate.

Key Term: qualifying interest in possession
An interest under a trust giving an immediate right to income (or equivalent enjoyment) where the beneficiary is treated for IHT as beneficially entitled to the relevant trust capital (e.g. an immediate post-death interest).

Key Term: gifts with reservation of benefit
Anti-avoidance rules that bring back into the donor’s death estate property given away during lifetime where the donor retained a benefit (e.g. occupation without market rent).

Excluded property (not taxed in the UK) includes, for example, non-UK assets owned by a person domiciled outside the UK and certain reversionary interests.

Key Term: excluded property
Property not subject to UK IHT, such as non-UK assets of a non-UK domiciled person or certain trust interests.

Note that assets may pass outside the estate for probate purposes but still be relevant to IHT liability (e.g. jointly owned assets passing by survivorship; certain nominated benefits; property disposed of by donatio mortis causa is a lifetime transfer rather than a testamentary disposition, and PRs may be accountable for IHT attributable to such property).

Valuing the Estate and Deducting Liabilities

The value of the estate is the open market value of all included assets at the date of death. Valuation follows established practice:

• land and buildings at market value on the date of death
• quoted shares at the market value (usual “quarter-up” method for valuation days)
• unquoted shares based on a fair market valuation (considering control, profitability, and marketability)
• joint property usually valued on a fractional basis unless related property rules apply (e.g. spouses) which can affect discounts

Liabilities incurred for full consideration (e.g. mortgages, loans, unpaid bills) are deductible, provided they are not linked to excluded property or taken out for tax avoidance. Funeral expenses are deductible. The small gifts annual exemption does not apply to the death estate (it only applies to lifetime transfers).

Where tax must be apportioned between different items of property (e.g. for instalment option on land, or where settled property is included), the estate rate may be used.

Key Term: estate rate
The average rate of IHT across the chargeable estate used to apportion tax to particular assets proportionally by value (total IHT divided by total chargeable estate).

Key Term: nil rate band
The threshold up to which IHT is charged at 0%. For 2023/24, the nil rate band is £325,000.

Key Term: residence nil rate band
An additional threshold (up to £175,000) available when a main residence is left to direct descendants.

Applying the Nil Rate Band and Residence Nil Rate Band

The nil rate band (NRB) is the amount up to which no IHT is charged. The standard NRB is £325,000. If the deceased leaves a qualifying residence to direct descendants, the residence nil rate band (RNRB) may apply, increasing the total tax-free threshold (up to £500,000 for an individual, or £1 million for a couple if both bands are fully available and transferred).

The RNRB applies where a qualifying residential interest is “closely inherited” by lineal descendants (children, grandchildren and their spouses/civil partners). It does not apply to lifetime gifts of the residence; it is a death-only allowance. Downsizing provisions may preserve RNRB where the deceased sold or downsized after July 2015 and assets equivalent in value are left to direct descendants.

The RNRB is reduced by £1 for every £2 the estate exceeds £2 million (tapering). Any unused NRB or RNRB from a predeceased spouse or civil partner can be transferred to the survivor’s estate (the transferred amount is determined by the unused percentage at the first death and applied to the bands in force at the second death).

Worked Example 1.1

A deceased leaves an estate worth £600,000, including a home worth £300,000 left to her children. She has not made any lifetime gifts. What is the IHT due?

Answer:
The estate benefits from the NRB (£325,000) and the RNRB (£175,000), totalling £500,000 tax-free. The taxable estate is £600,000 – £500,000 = £100,000. IHT at 40% is £40,000.

Where the estate exceeds £2 million, calculate the tapered RNRB before applying the tax rates. If 10% or more of the net estate is left to charity, the death rate on the remainder may be reduced to 36% (see below).

Main Exemptions and Reliefs

Certain assets or gifts are exempt from IHT on death:

• Transfers to a spouse or civil partner (if both are UK domiciled). If the recipient spouse/civil partner is non-UK domiciled, a monetary cap on the exemption applies unless an election for UK domicile is made (current cap aligns with the NRB).
• Gifts to UK charities (and certain EEA charities)
• Gifts to some national institutions and qualifying political parties

Key Term: spouse exemption
Assets left to a surviving spouse or civil partner are exempt from IHT, subject to domicile limits for the recipient spouse.

Key Term: charity exemption
Gifts to qualifying charities are exempt from IHT.

Reliefs can also reduce the value of assets subject to IHT:

• Business Property Relief (BPR): up to 100% relief for qualifying business assets (e.g. a sole trade or partnership interest; shares in an unlisted trading company). Some assets qualify for only 50% relief (e.g. certain controlling shareholdings with loans).
• Agricultural Property Relief (APR): up to 100% relief for the agricultural value of qualifying farmland and buildings, subject to occupation/ownership periods (typically two years’ occupation by the transferor or seven years if tenanted) and “character appropriate” tests for farmhouses.

Core BPR/APR points frequently examined:

• Minimum ownership periods for BPR (generally two years), aggregated in certain circumstances (e.g. on spousal inheritance).
• Excepted assets (non-business assets parked within a business) do not benefit from BPR.
• A binding contract for sale may disqualify BPR at death.
• APR may be available in priority on the agricultural value; BPR may then apply to non-agricultural business assets (e.g. plant and machinery, goodwill), subject to conditions.

Clawback: where a lifetime transfer benefitted from BPR/APR and the donor dies within seven years, relief may be withdrawn if the property ceases to qualify or is not retained by the transferee in qualifying form until death. Always check the retention and replacement rules.

Key Term: business property relief
A relief reducing the value of qualifying business assets for IHT, often by 100%, subject to qualifying conditions (e.g. ownership period, trading status, no binding sale).

Key Term: agricultural property relief
A relief reducing the value of qualifying agricultural property for IHT, often by 100%, subject to occupation/ownership periods and character appropriate tests.

Worked Example 1.2

A deceased leaves £1 million, including a farm worth £500,000 qualifying for 100% APR, and the rest in cash. All is left to his children. What is the taxable estate?

Answer:
The farm is relieved by APR, so only £500,000 (cash) is taxable. After applying the NRB and RNRB (£500,000), there is no IHT to pay.

Lifetime Transfers Affecting IHT on Death

Lifetime gifts made within seven years of death may become chargeable on death. Potentially exempt transfers (PETs) to individuals are taxed only if the donor dies within seven years. Chargeable lifetime transfers (CLTs), such as gifts to most trusts, are immediately chargeable at the lifetime rate if above the NRB and are reconsidered if the donor dies within seven years.

Key mechanics:

• Cumulation: when assessing NRB available for gifts at death, prior chargeable transfers in the seven years before each transfer reduce the NRB available. Each gift has its own seven-year cumulation period. This can result in “14-year” effects where earlier CLTs (outside seven years of death) still reduce the NRB available to a PET made within seven years of death.
• Taper relief: reduces the death tax payable on gifts made more than three years before death, by percentage bands based on time elapsed. It reduces the tax, not the transfer value.
• Credit on CLTs: any lifetime tax paid on a CLT is credited against the death charge, but there is no refund if the lifetime tax exceeds the death tax.

Key Term: taper relief
A reduction in death IHT payable on lifetime transfers based on the time between gift and death (no reduction in transfer value).

Worked Example 1.3

A person made a £200,000 PET to his son four years before death and leaves an estate of £400,000 to his daughter. What is the IHT due?

Answer:
The PET becomes chargeable. The NRB (£325,000) is used first against the PET, leaving £125,000 for the estate. The taxable estate is £400,000 – £125,000 = £275,000. IHT at 40% is £110,000. Taper relief may reduce the tax on the PET.

Worked Example 1.4

In January 2018, Dia gives £300,000 to a discretionary trust (CLT). Trustees pay lifetime IHT at 20% on the excess over any available NRB. Dia then gives £210,000 to her daughter in March 2020 (PET). Dia dies in May 2024 with a net death estate of £450,000, leaving her home to her grandson.

Answer:
On death, recalculate:

• The PET (March 2020) becomes chargeable. For the PET’s cumulation period, look back seven years to identify prior CLTs (the 2018 CLT is within seven years and reduces the NRB available to the PET).
• Apply NRB first to the PET, then any remaining NRB to the death estate.
• Taper relief may reduce death tax on the PET depending on the timing (>3 years before death).
• The CLT attracts additional death tax at 40% (with taper relief if between 4–6 years before death), less credit for lifetime IHT paid.
• Provided the residence passes to a lineal descendant, apply RNRB (subject to tapering if the estate exceeds £2 million).

The Order of Applying Exemptions, Reliefs, and Nil Rate Bands

When calculating IHT on death:

• value the estate and deduct allowable liabilities (no annual exemption applies on death)
• identify and apply exemptions first (spouse/civil partner, charity, certain bodies)
• apply reliefs (BPR, APR) to qualifying assets to reduce the chargeable estate
• use the NRB cumulatively against chargeable lifetime transfers within seven years of death first, then apply any remaining NRB to the death estate
• apply the RNRB (including any transferred amount) to a qualifying residential interest passing to lineal descendants, taking into account tapering above £2 million
• compute IHT at 40% on the remainder (or 36% if at least 10% of the net baseline amount passes to charity)

If 10% or more of the net estate is left to charity, the IHT rate on the rest of the estate may be reduced to 36%.

Exam Warning

Always check for lifetime gifts within seven years of death, as these can reduce the NRB available to the death estate and may trigger additional IHT. Do not apply annual exemptions to the death estate. Confirm RNRB conditions carefully: the residence (or downsizing equivalent) must be closely inherited by direct descendants, and the RNRB tapers for estates over £2 million.

Payment and Burden of IHT

Personal representatives (PRs) are responsible for paying IHT due on the estate before distributing assets. IHT is usually due six months after the end of the month of death. In some cases, IHT on certain assets (e.g. land, businesses, controlling or certain unquoted shareholdings) can be paid in instalments over ten years; first instalment due on the normal due date. If the property is sold, the outstanding tax becomes payable.

Key Term: personal representatives
Executors or administrators responsible for collecting in the estate, paying debts and taxes, and distributing assets to beneficiaries.

Liability and burden vary with the property concerned:

• Non-settled free estate: PRs are liable for IHT attributable to property passing under the will or intestacy. The burden typically falls on the residue unless the will provides otherwise. PRs are also accountable for IHT attributable to certain property passing outside the will (e.g. joint assets by survivorship; nominated property; donatio mortis causa).
• Settled property (qualifying interest in possession): trustees are liable for IHT on that property; the burden falls on the trust fund.
• Gifts with reservation of benefit: the donee is primarily liable for IHT attributable to the property; if unpaid 12 months after the end of the month of death, PRs become liable (limited to assets in their hands).
• PETs that become chargeable: the recipient is liable for death tax on the PET; PRs may become liable after 12 months if unpaid (limited to estate assets).

Direct payment arrangements with UK banks can be used to pay IHT due before the grant; PRs may also borrow (e.g. bank loan or a private loan from a beneficiary) to meet IHT if the estate lacks liquidity.

Post-mortem reliefs and other reductions

• Quoted shares and unit trusts: if PRs sell within 12 months at a loss, a claim may substitute the lower sale proceeds for IHT purposes (aggregating all sales and purchases in the period).
• Land and buildings: similar relief if sold at a loss within three years of death (profits and losses over the period are aggregated; losses in the fourth year may be included and profits ignored).
• Woodlands relief: value of growing timber may be excluded at death with tax deferred until sale of timber (conditions apply; not available where APR applies).
• Quick succession relief: reduces IHT on a death where the deceased’s estate had been increased by a chargeable transfer received in the previous five years (relief diminishes by 20% per year elapsed).

Key Term: quick succession relief
A relief that reduces IHT where a person dies within five years of receiving a transfer on which IHT was paid; the reduction steps down by 20% for each year elapsed.

Anti-avoidance reminder: where gifts with reservation are avoided by paying full market rent (e.g. continued occupation of a gifted house), IHT may be mitigated; otherwise the house is treated as part of the donor’s death estate. Pre-Owned Asset Tax may impose an income tax charge in certain arrangements where GWR does not apply.

If the estate includes assets passing outside the will (e.g. jointly owned property by survivorship, life insurance written in trust), these are not usually included in the death estate for IHT unless the deceased retained a benefit (e.g. GWR). However, liability/accountability rules may still make PRs accountable for IHT attributable to some such property.

Worked Example 1.5

Kira dies owning a house (£600,000), unquoted trading company shares (£150,000; 15% holding), bank deposits (£100,000), and a joint bank account (£80,000 joint with her brother). She also had an immediate post-death interest in a trust worth £200,000 (income for life). She made a PET of £200,000 to her son four years before death, and no CLTs. She leaves the house to her daughter, residue to charity.

Answer:

• Trust: the £200,000 trust fund is aggregated with Kira’s death estate (qualifying IPDI). Trustees are liable for the IHT attributable to that settled property.
• BPR: check qualification; a 15% unquoted trading shareholding may qualify for 100% BPR if conditions met (no binding sale; relevant business property).
• PET: becomes chargeable; apply NRB first against the PET; taper relief reduces the tax payable on the PET (4–5 years band).
• RNRB: the residence passes to a lineal descendant; apply RNRB (subject to tapering if the estate exceeds £2 million).
• Charity: residue left to charity; the remainder of the estate may qualify for the 36% rate if the charity gift meets the 10% test.
• Liability/burden: PRs are liable for free estate tax; trustees for trust property; the son is liable for PET tax; the surviving joint account holder bears IHT attributable to the joint asset, though PRs may be accountable.

Key Point Checklist

This article has covered the following key knowledge points:

• The death estate for IHT includes all assets to which the deceased was beneficially entitled, plus certain deemed interests (qualifying interests in possession and gifts with reservation), less allowable liabilities.
• The nil rate band and residence nil rate band provide tax-free thresholds; unused bands may be transferred from a predeceased spouse or civil partner; the RNRB tapers for estates over £2 million and has downsizing provisions.
• Main exemptions include spouse/civil partner and charity exemptions; main reliefs include business and agricultural property reliefs with specific qualifying conditions and clawback risks.
• Lifetime gifts within seven years of death may reduce the nil rate band available to the estate; PETs become chargeable on death, and CLTs may attract additional death tax (with taper relief and credit for lifetime tax).
• Annual exemptions do not apply to the death estate.
• The correct order of calculation is exemptions, reliefs, NRB (against lifetime transfers and then estate), RNRB, then tax at 40% (or 36% if the charity threshold is met).
• Personal representatives are responsible for paying IHT on the free estate; trustees for settled property; recipients pay IHT on PETs; donees pay IHT on gifts with reservation; PRs may become liable after 12 months if unpaid.
• IHT is due six months after the end of the month of death; instalments may be available for certain assets; if instalments are chosen and the asset is sold, outstanding tax becomes payable.
• Post-mortem reliefs (shares, land) and quick succession relief can reduce IHT; always consider whether claims are available.

Key Terms and Concepts

• death estate
• excluded property
• nil rate band
• residence nil rate band
• spouse exemption
• charity exemption
• business property relief
• agricultural property relief
• qualifying interest in possession
• gifts with reservation of benefit
• taper relief
• estate rate
• quick succession relief
• personal representatives