Learning Outcomes
After reading this article, you will be able to explain how Inheritance Tax (IHT) applies to transfers on death, identify which assets are included in the death estate, apply the nil rate band and residence nil rate band, and determine when exemptions and reliefs (such as spouse, charity, business, and agricultural reliefs) reduce IHT liability. You will also be able to outline the process for calculating IHT on death and recognise common exam pitfalls.
SQE1 Syllabus
For SQE1, you are required to understand the application of Inheritance Tax to transfers on death. Focus your revision on:
- the definition and composition of the death estate for IHT purposes
- the calculation and application of the nil rate band and residence nil rate band
- the main exemptions and reliefs available on death (including spouse/civil partner, charity, business, and agricultural reliefs)
- the process for valuing assets and deducting liabilities
- the order of applying exemptions, reliefs, and nil rate bands in IHT calculations
- the effect of lifetime transfers within seven years of death on the IHT due on death
- the statutory rules for the burden and payment of IHT on death
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.
- Which assets are included in a person's estate for IHT purposes on death?
- What is the nil rate band, and how does the residence nil rate band interact with it?
- Name two main exemptions and two main reliefs that can reduce IHT on death.
- 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 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
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.
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. 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.
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 is reduced by £1 for every £2 the estate exceeds £2 million. Any unused NRB or RNRB from a predeceased spouse or civil partner can be transferred to the survivor’s estate.
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.
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)
- Gifts to UK charities
- Some national bodies and political parties
Key Term: spouse exemption Assets left to a surviving spouse or civil partner are exempt from IHT, provided both are UK domiciled.
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
- Agricultural Property Relief (APR): up to 100% relief for qualifying agricultural property
Key Term: business property relief A relief reducing the value of qualifying business assets for IHT, often by 100%.
Key Term: agricultural property relief A relief reducing the value of qualifying agricultural property for IHT, often by 100%.
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 only taxed if the donor dies within seven years. Chargeable lifetime transfers (CLTs), such as gifts to most trusts, are always considered.
If the deceased made chargeable gifts within seven years, these use up the NRB first, reducing the amount available to the death estate. Taper relief may reduce the IHT due on gifts made more than three years before death.
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.
The Order of Applying Exemptions, Reliefs, and Nil Rate Bands
When calculating IHT on death:
- Value the estate and deduct allowable liabilities.
- Apply exemptions (spouse, charity, etc.).
- Apply reliefs (BPR, APR).
- Apply the NRB and RNRB (including any transferable amounts).
- Apply IHT at 40% to the remaining taxable estate.
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.
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, unquoted shares) can be paid in instalments over ten years.
Key Term: personal representatives Executors or administrators responsible for collecting in the estate, paying debts and taxes, and distributing assets to beneficiaries.
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.
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, 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.
- Main exemptions include spouse/civil partner and charity exemptions; main reliefs include business and agricultural property reliefs.
- Lifetime gifts within seven years of death may reduce the nil rate band available to the estate.
- Personal representatives are responsible for paying IHT before distributing the estate.
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
- personal representatives
