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Ask an expert: ‘How much inheritance tax will my children pay if I leave them my £500,000 home?’

The new tax-break that covers your property explained

Every week, Which?’s money experts answer your financial queries. You can submit your questions to money-letters@which.co.uk, or via our Facebook or Twitter pages.

Q. I’m a single, 69 year-old woman with two children from a previous relationship. I’ve been really lucky with my home in London – I bought it in 2006 for £250,000 and it’s now worth just under £500,000.

I don’t have much in the way of other assets, and have no plans to downsize, so I want my children to benefit from the growth in the value of my house. But will they be hit with a huge inheritance tax bill? Is there anything I can do to prevent this?

Supplied via email.

A. Your case is typical of many people, who have found themselves with an unexpectedly large estate because of rising house prices.

Let’s start with inheritance tax. Your heirs pay tax at 40% on anything they inherit above your personal inheritance tax-free allowance – technically called your ‘nil-rate band’. This is £325,000 for an individual.

Married couples inherit all assets from their spouse tax-free, as well as any unused inheritance tax allowance, meaning they can pass on up to £650,000 to their heirs. But as you’re unmarried, you have just your £325,000 nil-rate band to offset any inheritance tax bill for your children.

The good news is that a new rule was introduced this month, which allows you to pass on an extra £100,000 to your children, provided that your estate includes your main home. And this new allowance –the ‘residence nil-rate band’ – rises every year until 2020, when it will reach £175,000.

The table below shows how this works and the total amount you can pass on inheritance tax-free in a few years’ time.

Tax year Standard nil-rate band Residence nil-rate band Total inheritance-tax free allowance
2017-18 £325,000 £100,000 £425,000
2018-19 £325,000 £125,000 £450,000
2019-20 £325,000 £150,000 £475,000
2020-21 £325,000 £175,000 £500,000

Will my children have an inheritance tax bill to pay?

If you were to die this year and your property was the only asset they inherited, your children would face a tax bill of £30,000. That’s 40% on the difference between £500,000 (the value of your home) and £425,000 (your total nil-rate band ).

According to this nifty calculator from the Office for National Statistics, however, a woman of your age has a life expectancy of 89, a one in four chance of reaching 96 and a one in 10 chance of reaching 100.

By 2020, you’ll be able to pass on £500,000 tax-free. After that, the residence nil-rate band will rise with inflation every year.

Now, here’s the tricky part – I don’t have a crystal ball and can’t tell you that property prices will follow the same trajectory as they have in the past decade. So, it’s impossible to know what your home will be worth in two decades time when your children may inherit the property – if you’re still living in it.

What are my options to reduce inheritance tax?

You could reduce the size of your estate to below your total inheritance tax allowance by giving money to your children now. One way to realise that cash would be to downsize to a cheaper property.

And if you decide to downsize, your children will still benefit from the residence nil-rate band that applied to your previous, more expensive home.

You can give away as much as you like tax-free – so long as you live for seven years after making the gift. These are known as ‘potentially exempt transfers’, and the seven-year rule exists in order to prevent people giving money away on their death bed to avoid a tax bill. You can also give away £3,000 a year tax-free, as well as smaller gifts.

Our guide explains how gifts for inheritance tax work.

There are other options available, such as releasing equity from your home. But this is a serious decision, and you would probably benefit from some professional advice. Our money helpline can talk you through some of your options.

Can I just give my home to my children now and live in it?

If you gave your property away and continued to live in it rent-free, it would be be deemed a ‘gift with reservation’ and therefore still form part of your estate for inheritance tax purposes.

If you gave your property away to your children, you would need to do the following in order ensure it falls out of your estate:

  • pay full market rent to the new owners (your children)
  • you pay your share of the bills
  • and live there for seven years or more
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