Just under nine out of 10 properties sold in England and Wales last year exceeded the inheritance tax threshold, exclusive new research from Which? can reveal, showing how the new tax-free allowance has brought thousands of estates out of the tax trap.
A new inheritance tax (IHT) allowance was introduced in 2017, giving individuals an extra £100,000 to pass on if their estate included their family home. This year, the allowance – the ‘residence nil rate band’ – rose to £175,000, allowing an individual to pass on a total of £500,000, and married couples and civil partnerships up to £1m.
Government tax receipts show that just 3.9% of estates paid IHT in 2017-18, the first year of the new nil-rate band, causing IHT revenues to fall for the first time in eight years.
But our analysis of property sales and official IHT statistics show that some areas of the UK will benefit more than others.
Because the new residence band is tied to property, where you live and the average property price in your area will have a big impact on how likely you are to still end up with a bill to pay.
In fact, figures for 2017/18 show that more than half (53%) of inheritance revenue for England and Wales came from London and the South East alone.
So while the changes mean thousands of people will no longer need to worry about IHT, there are still many who live in a tax hotspot.
How do the inheritance tax allowances work?
When you die, anything left to your spouse or civil partner is passed on free from tax.
When leaving something to anyone else, everyone has access to a ‘nil rate band’ (NRB) which has been set at £325,000 since 2009. This can be used when leaving any asset you have to anyone you choose.
However, in response to rising property prices, the government introduced a second band in the 2017-18 tax year – the residence nil-rate band – which granted you an additional £100,000 allowance when passing on your main residence.
Because this was part of former Chancellor George Osborne’s plan to ‘take the family home out of inheritance tax’, it only applies to direct descendants, such as children, grandchildren or stepchildren.
The residence nil-rate band has been rising by £25,000 each year since, until it reached £175,000 in April 2020. This means that, between the two bands, an individual can now pass on a property worth up to £500,000 tax-free.
You can transfer any unused IHT allowances to your spouse or civil partner. This means married couples and civil partnerships could pass on up to £1m free of tax.
Find out more about leaving your estate to your spouse in our guide for married couples and civil partners.
What impact has the new band had?
Before the new residence band was introduced, data from Land Registry shows that more than one in four properties in England and Wales were being sold above the threshold of £325,000.
As the below chart shows, the addition of the extra £100,000 allowance in 2017/18 caused a big drop in the number of houses sold above the combined allowances, to 17%.
Figures from HM Revenue and Customs (HMRC) show that more than 20,000 people benefited from the new band in its first year, making a collective saving of £3.1bn.
Because numbers from HMRC are a few years behind, it will be a while before we see the exact impact of the subsequent increases in the new property allowance. However, Land Registry data shows that the number of homes sold above the combined bands fell to just 13% in 2019.
This is good news if you’re worrying about IHT and your main asset is your property. This is especially true if you are married or in a civil partnership, as fewer than 3% of properties sold in 2019/20 were for more than £950,000 – the combined maximum allowance for a couple.
Unfortunately, these proportions are for England and Wales as a whole and will vary by where you are in the country. Some areas will still have a significantly higher chance of paying IHT.
Where are the inheritance tax hotspots?
We’ve used Land Registry data to see which local authorities in England and Wales have the highest proportion of properties sold above the new £500,000 threshold.
As you can see from the map, the red areas – those with the highest concentration of half-a-million-pound houses – tend to centre around London and the surrounding counties.
In fact, nine of the 10 authorities with the highest proportion of £500k properties are in London.
Kensington and Chelsea tops the list, with a whopping 85% of properties selling for above £500k. In fact, 58% of properties sell for more than £1m.
No wonder Kensington and Chelsea generates twice as much IHT revenue as the whole of the North East combined.
While high prices aren’t limited to London, it does expose a north-south divide.
Just two of the top 100 local authorities with the highest percentage of properties selling for over £500k are in the north: Harrogate and Trafford. The rest are in the south and overwhelmingly in the home counties: with the likes of Surrey, Buckinghamshire and Hertfordshire all well represented.
The fact is, if you’re in the north of the country and your main asset is your property, your chance of paying inheritance tax is much lower.
Outside of London and the South East, it tends to be the more picturesque areas that attract higher prices. Both the rolling hills of the Cotswolds and the tranquil confines of the New Forest, for example, entice more than a fifth of buyers to part with £500,000 or more for a home.
You can also search our table below, to see where your local authority ranks, and whether it is above or below the average of 13% for England and Wales.
Will coronavirus affect inheritance tax allowances?
From the next tax year, the residence nil-rate band will continue to increase, but in line with the consumer price index (CPI) rather than in £25,000 increments.
Forecasts from HMRC show that the number of people paying IHT is expected to gradually increase as a result. This is because property prices are expected to rise faster than inflation.
However, the government’s forecasts were made prior to coronavirus, which has had a profound effect on the economy.
While there are signs that the housing market is recovering, if prices rise more slowly than expected, this will mean the increase in the number of people paying IHT will happen more slowly – if at all.
Again, this is assuming that no changes are made to inheritance tax rules.
Although there are currently no indications that Rishi Sunak will make changes to IHT, it remains one of many levers he could pull to help recoup the cost of putting the country on lockdown. We will find out in the forthcoming Autumn Budget.
Cutting your bill
If your estate does exceed the IHT threshold, you may want to consider giving money away to reduce your bill. Here are the ways you can give money away without IHT being an issue.
Gifts of under £3,000 – you can make gifts of up to £3,000 every year, without affecting your nil rate band. Any unused gift allowance can be carried forward, but only for one year.
Gifts of above £3,000 – gifts over £3,000 could be tax-free, but only if you live for more than seven years after making them. These are known as ‘potentially exempt transfers’ (PETs). Failed PETs are subject to ‘taper relief’ meaning tax can be as high as 40% if the death is within three years of the gift, or as low as 8% if the death takes place between six and seven years after the transfer.
Wedding gifts – You can give a wedding gift of up to £1,000 tax-free to anyone, rising to £2,500 for grandchildren or £5,000 for children.
Gifts below £250 – You can give gifts of up to £250 to as many people as you like each year, as long as you don’t give them other exempted gifts.
Donations to charities – A donation of 10% or more to charity means the rate applied to the taxable part of your estate drops from 40% to 36%.
For a full overview of how you can reduce your tax bill, see our guide on how to avoid inheritance tax.