How to avoid mistakes when inheriting in the UK: expert advice

A brief history of English inheritance tax

The prototype of the British inheritance tax was the Stamp Duty introduced at the end of the 17th century – a fixed fee, which was levied when dealing with inheritance cases under wills or transferring private property under powers of attorney. The fee was only 20 shillings, and the value of the property transferred by inheritance or power of attorney could be anything, as long as it was more than £20.

The next step was the emergence of inheritance tax in the late 18th and early 19th centuries, first in Ireland, England and Wales, and then in Scotland. The rates were symbolic, reporting and payment by heirs was voluntary (although penalties were introduced for failure to provide data on the inherited property), the tax was not assessed on inherited immovable property.

By 1894, the tax laws of the United Kingdom already had different rates of inheritance tax depending on who the heir to the deceased was, as well as the type of asset being passed on to the heirs and its market value.

From 1894, real estate was included in the taxable inheritance, while the real estate tax, which was levied in the process of transferring real estate into ownership, remained in force. In addition, the inheritance tax became progressive, the higher the total value of posthumous property, the higher the rate for heirs.

Between 1907 and 1946 the maximum rate of inheritance tax rose from 15 per cent to 75 per cent. It peaked in 1969 at 85 per cent on that part of the inheritance amount exceeding £750,000.

Gifts to older people in mid-20th century England also became taxable if the giver died within 3 years (before the 1946 Finances Act), 5 years (before the 1969 Finance Act) and 7 years (before 1975).

In 1975 the UK abolished inheritance tax and replaced it with a capital transfer tax. The disadvantage of this reform was that property gifted by the deceased was considered as transferred capital in any case, without any minimum period of lifetime ownership. In its essence, the English capital transfer tax was both an inheritance tax and a gift tax.

Inheritance tax in the form familiar to our contemporaries was introduced in the United Kingdom in 1986. As was often the case before, it replaced the capital transfer tax. In the same year, lifetime gifts to individuals ceased to be taxable, with an exception known as the “7 year rule”.

Inheritance tax in the UK

The British kingdom currently has a 40% rate of tax on inherited property whose value exceeds £325,000.

In the UK there are deductions and exemptions for certain circumstances and groups of heirs.

Gifts made during one’s lifetime are also taxable if the giver passed away early. In this case, the so-called “7-year rule” applies, according to which gifts made 7 years before the death of the donor are not taxable.

If the donor dies before 7 years, tax will have to be paid. The rate depends on the time elapsed between the date of the gift and death:

When calculating inheritance tax for gifts in England, exemptions and the non-taxable minimum are taken into account.

What deductions and exemptions apply in the UK when calculating inheritance tax?

1. Deduction for inheritance by spouses

If an estate is bequeathed to a husband, wife or civil partner by will after death, no inheritance tax is payable, even if the value of the assets exceeds £325,000.

Widows and widowers can also “inherit” the unused tax-free threshold percentage from their spouses, so that the heirs will then pay less tax. How does this work? Here’s an example:

The value of Richard’s estate is £450,000. In his will he left £65,000 to his son and the remainder to his wife Jennifer. The non-taxable threshold at the time of Richard’s death was £325,000 of which only £65,000 was utilised.

In percentage terms this is £65,000 / £325,000 *100% = 20%. This leaves 80% of the inheritance tax free threshold unused.

Unfortunately, Jennifer did not outlive her husband for long. She left her heirs an estate, a substantial part of the value of which will not be subject to inheritance tax because she took advantage of Richard’s unused threshold. The following amount will not be subject to inheritance tax:

325 000 + 325 000 * 80% = £585 000.

If for some reason a will has not been made, spouses are considered next of kin who inherit all or most of the inherited property:

2. Deductions at the main place of residence

If you inherit the flat or house where you live, you can also take deductions:

• If you pass on your home to your wife, husband or civil partner, no inheritance tax will be payable.
• If you own the house or flat in whole or in part, it will be possible to increase the tax-free threshold to £500,000 provided:
• you leave your home to your children or grandchildren;
• the value of your resident property does not exceed £2,000,000.
• If you donated your home and moved to another location, or if you stayed in your old place, but you pay the new owner rent at least equal to the current rates in the area and pay your share of the utility bills.

To ensure that your generous gift to an heir is not subject to inheritance tax, you must live for a further 7 years after the home is transferred to the new owner. It is also important to move out of the house or pay rent, otherwise your gift will be classed as a ‘qualified gift’ and included in the inheritance estate.

You won’t have to pay rent:

• if the new owner will be living with you in the same house or flat;
• if you only gift a portion of your residential property.
• If the home was jointly owned, for example with a spouse, upon death it is automatically and tax free to the living co-owner.

3. Deduction for inherited business or agricultural activities

Deduction for business inheritance

Heirs cannot claim an inheritance tax deduction if the deceased owned the assets listed in the table for less than 2 years before his or her death. Also some companies and assets are not eligible for the inheritance tax deduction.

Deduction for inheritance of agricultural property

Owners of agricultural property can inherit it by will or during their lifetime without paying inheritance tax if it is arable land and pasture land used for growing crops and raising animals.

Assets that can be passed on free of inheritance tax also include:

• growing crops;
• stud farms for breeding and raising horses and grazing cattle;
• planted fruit trees that produce a crop at least once every 10 years;
• Land that is not currently being farmed under the UK’s Habitat Scheme;
• Land that is not currently being farmed as part of a crop rotation programme;
• the amount of dairy quota associated with land;
• certain agricultural stocks and securities;
• outbuildings, farm cottages and houses.

The following types of agricultural property cannot be passed on without paying inheritance tax:

• agricultural equipment and machinery;
• harvested crops;
• livestock;
• abandoned buildings;
• property subject to a mandatory contractual sale.

Additional conditions for obtaining an agricultural tax deduction

The listed facilities must be part of a working farm within the UK and used for their intended purpose directly by the owner or leased to another farmer.

Moreover, the listed assets must be used for agricultural purposes for a period of time:

• 2 years – by the owner, the owner’s company or the owner’s husband, wife or civil partner;
• 7 years – if the assets are used by someone else.

4. Deductions for donations and charity

A person becomes entitled to inheritance tax at a reduced rate of 36% if they donate at least 10% of their estate to charity.

The deduction can be used either by the owner of the property himself when making his will, or by his executor or administrator. To qualify for this benefit, you should calculate the exact value of the assets owned by the testator, taking into account unpaid debts, gifts made in the last 7 years, the current non-taxable threshold, etc. Also note that certain types of property, such as forestry plots and cultural heritage properties, are only subject to inheritance tax at the standard rate of 40%.

The pros and cons of inheritance tax in the UK

Beginning with a small stamp duty on inheritance, which in the 17th century went to war, the British kingdom gradually changed the law of finance until inheritance tax took its modern form, with a rate of 40 per cent, the ‘7 year rule’ on gifting and numerous deduction possibilities.

Does UK inheritance tax have advantages?

From the point of view of the state and modern society, there certainly is. In this form of inheritance tax:

• Provides a flow of funds to finance the needs of the state.
• Reduces inequality in British society through the distribution of private capital.
• Controls the inheritance of large fortunes.

The disadvantages of this tax affect mainly the interests of the heirs:

• It is not uncommon for an inherited property to first need to be sold in whole or in part so that the 40% tax can be paid.
• The UK has a complex system of inheritance tax deductions which can be difficult to understand on your own without expert legal advice.
• In some cases, inheritance tax places a heavy burden on heirs.

How to make the inheritance process painless in England?

Unfortunately, life is fleeting, so wealthy elderly people prepare in advance for inheritance. As a rule, several tools are used for this purpose at once – from restructuring the estate to drawing up a will that is well thought out to the last detail.

And, of course, for an effective solution to the issue of transfer of inheritance can not do without professional legal assistance. With the help of an experienced lawyer you will be able to:

• Accurately follow all the formalities of the probate process and ensure your posthumous will has the force of law.
• Optimise tax liabilities and thereby reduce costs to heirs.
• Prevent potential conflicts and disputes between your heirs.

Although people avoid death-related topics, statistics show that up to 2/3 of the UK’s pension age population have already contacted a solicitor and made a Will so that they can pass on their assets to their heirs painlessly at a later date.