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20 Nov 2019

Over 4,500 people got an inheritance tax refund last year - could you?

HMRC's death tax doesn't account for falling property prices

The number of people successfully getting inheritance tax refunds has more than doubled in the past two years, with more than 4,500 people receiving money back from HMRC in 2018-19.

It's possible to claim this kind of refund if you sell an inherited property for less than the value you paid tax on, provided you sell it within four years of the death.

While 2,177 applied for an inheritance tax (IHT) rebate in 2016-17, the figure surged to 4,516 in 2018-19, according to data obtained by NFU Mutual via a Freedom of Information (FOI) request.

It's a trend that looks set to continue: 2,019 refunds have already granted in the first seven months of 2019, likely due to the slowdown in the housing market.

Here, Which? explains how inheritance tax on property works, what you need to do to apply for a refund and what IHT rates you could face.

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How much IHT do you pay on an inherited property?

While everyone is entitled to the £325,000 nil-rate band allowance - the value of your estate that can be passed on tax-free - there's an additional 'residence nil-rate band' for those passing on property.

The tax-free amount depends on who you leave the property to and the overall value of your estate.

In 2019-20, the residence nil-rate band is £150,000. From April 2020, it will have reached its maximum value of £175,000. Paired with the nil-rate band, it means each person can pass on up to £500,000 IHT-free, or up to £1m as a couple.

However, only 'direct descendants' - that's children and their spouses/civil partners, grandchildren, stepchildren, adopted children, foster children and great grandchildren - can benefit from this extra allowance.

The likes of nieces, nephews and siblings can't benefit from the residence nil-rate band, and the 40% inheritance tax rate will apply after £325,000.

The tax owed is usually taken out of the estate, either directly from things like savings accounts, or from the sale of valuable items such as a house, car or artworks.

Who can get an IHT property refund?

You're entitled to an IHT refund if a property you've inherited sells for less than it was valued at for the purposes of IHT.

The sale must occur within four years of the date of death for you to be able to claim a refund.

It's worth noting that HMRC won't automatically alert you if you've paid too much tax: 'Rebates are not given automatically and need to be proactively claimed,' says Sean McCann, chartered financial planner at NFU Mutual.

'Those that opt for do-it-yourself probate are not always aware that inheritance tax can be claimed in this way.'

This rule does not apply for any land or property that was transferred while the deceased person was alive.

How much of a refund could you get?

The refund available depends on how the property value has changed since the time of death.

According to the latest Land Registry data, property prices in Richmond upon Thames have decreased by 3.9% year on year. This means an average property costing £650,810 in September 2019 would have been worth £676,192 the year before.

In terms of IHT, HMRC would charge £140,477 inheritance tax on the original cost of the property (this is 40% of what's left after the £325,000 nil-rate band is taken from the property value). If you sold the property a year later, you could get a refund of £10,153.

If the residence nil-rate band also applies (which was £125,000 in 2018-19) you'd have an initial tax bill of £90,477, but could get exactly the same refund.

How to claim an inheritance tax refund

To claim an IHT refund, you'll need the IHT38 form.

There's little in the way of advice on how the refund rules work, so you must make sure you read all of the notes on the form.

A few things to be aware of:

  • Only the 'appropriate person(s)' can make the claim - that is, the person who has either paid the tax or who has an obligation to pay it. All appropriate persons must sign.
  • You can't claim the relief if no IHT is due - you must have made an IHT payment.
  • The sale price must be at least 5% or £1,000 different from the value on death - whichever is lower.
  • You can't withdraw a claim - and the IHT bill could increase as well as decrease.

For help filling in the form, you can call HMRC on 0300 123 1072.

How to reduce your inheritance tax bill

If you want to reduce the IHT burden your heirs are left with, there are things you can do while you're alive to reduce the amount of tax due.

Here are a few methods to consider:

  • Leave money to a charity: money left to UK-registered charities is always free from IHT. Plus, if you donate more than 10% of your estate to charity, the overall IHT rate of the rest of your estate will be reduced to 36%.
  • Give gifts: there are currently lots of gift allowances you can use to reduce the value of your estate, including up to £5,000 as a wedding gift to your children, up to £3,000 as a gift each tax year, and unlimited gifts of up to £250. You can give bigger sums of money, but they may be taxable if you die within seven years of giving them.
  • Think carefully before using equity release: taking money out of your property can free up some cash if you need it, but equity release schemes will just reduce the assets you own and increase the debts that will count against your estate.
  • Take out a life insurance policy: when you die, a life insurance policy payout can cover the cost of an IHT bill. But they can be expensive if you're older or have any health issues when you take one out.
  • Draw up a 'deed of variation': this allows your heirs to alter your will after you die, meaning they could reduce the IHT owed for themselves. However, all affected beneficiaries must agree to any changes, and it can cause family squabbles.

We'd suggest consulting an independent financial adviser to make sure the choices you make are best for you.