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When a loved one passes away and leaves us a portion of their estate, there is often an inheritance tax attached to this estate, which will need to be paid. Here, we’ll examine exactly what that tax is, why it exists and if it applies to you, alongside many other common questions.

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What is inheritance tax?

The clue is in the title, as it is quite literally a tax on your inheritance. Or, more accurately, on the estate of the person who has died. Basically, when you die, the government will assess how much your estate is worth and will take what it feels it is owed from this estate. Your estate will be made up of everything from the actual money in your bank, to any property or businesses you own, vehicles, investments and even life insurance payouts.

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When do I have to pay inheritance tax?

You will have to pay inheritance tax on any estate worth £325,000 or above. This is known as the inheritance tax threshold. Above that amount, anything you leave behind is taxed. If the estate is worth less than this, no inheritance tax will be due. You will also be able to avoid inheritance tax if everything in the estate is being left to a spouse, civil partner or charity. If you’re married or in a civil partnership and your estate is worth less than £325,000, you can also transfer any unused threshold to your partner when you die, meaning their threshold can be as much as double this amount (£650,000).

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What is the main residence nil rate band?

In July 2015, it was announced that the government would be introducing a main residence nil rate band on top of the existing threshold in April 2017. The initial allowance will be £100,000 in 2017, and it will increase by £25,000 every year until 2020, when it will settle at £175,000. After this, it will increase alongside inflation. Take note, however, of the fact that this new allowance only applies if you want to pass your primary residence to a direct descendant. When added to your the threshold, this could potentially give you an overall allowance of £500,000, or £1 million if you are married/in a civil partnership.

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How much is inheritance tax?

This will obviously depend on the size of the estate in question, but regardless of the size, inheritance tax will always be charged at a flat rate of 40%. Meaning that, for example, on an estate worth £400,000, you would pay 40% tax on £75,000 of it (a total of £30,000) to the government. Take note, however, that there is a reduced rate of 36% if 10% or more of the estate is left to charity in the Will of the deceases.

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Who pays the inheritance tax?

Funds from the estate itself will generally be used to pay funds directly to the HMRC by the executor of the Will (if there is one) or whoever else has been appointed to handle the process if there is not. Take note that the beneficiaries who will inherit your estate will often not actually pay any tax themselves, though there are exceptions. For example, if they are receiving rent from a property left to them in a Will. In this case, upon your death, the beneficiaries may be left with a bill that must be paid before receiving the remainder of your estate. This must be paid within six months from the date of your death, and failure to settle the bill will result in interest being charged by HMRC. Once this has been paid, your beneficiaries should receive a Grant of Probate, allowing them legal access to your assets.

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Gifts vs Tax?

You will also have to pay inheritance tax on gifts given over the value of £325,000, but only if you die within 7 years of passing on said gifts. This means that planning early who you’re going to be giving your assets away to is definitely recommended. Obviously giving all of your money away seven years before you die isn’t necessarily a smart option for most people, but giving a portion of it away earlier might be something to at least consider. You can also give £3,000 worth of gifts each year without them being taxed. This is referred to as your “Annual Exemption.” You can also give as many small gifts (under £250) as you like as long as they’re to different people.

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Why do we have to pay inheritance tax?

We could be cynical here and say it’s because the government can get away with it, but in all honesty, the politics surrounding it are incredibly complex from both a logistical and moral standpoint. The concept was originally implemented supposedly in order to cut down on inherited wealth and distribute the money that would just be inherited by rich kids of rich parents more evenly for the overall national benefit. There are arguments against it, however, primarily from those who feel that, as the money being taxed was already taxed when it was first earned, it’s effectively being taxed twice. Also, with the increase in house prices in recent years, inheritance tax affects more and more people every year. Not just the super rich 1%.

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Are there exemptions from inheritance tax?

Besides the aforementioned spouses, civil partner and charities, those who die in active service (armed forces, police, firefighters, humanitarian aid workers, firefighters, paramedics etc.) might be exempt from paying inheritance tax. This might also be true if the person in question has their death hastened by an injury sustained during active service. This is a sticky area, however, and every situation will be different so please don’t take anything as gospel here. If you are unsure whether or not you quality, you might want to contact the HMRC and ask them directly.

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Do I have to pay council tax on jointly owned property?

If you’re not married, but own assets jointly, things will get a little more complicated, especially regarding residential properties. Whether or not you have to pay inheritance tax will depend on if you are listed as ‘joint tenants’ or ‘tenants in common’ and, of course, if there is a Will. Joint tenants own the property equally, so if your partner left you everything, then their assets that exceed £325,000 will need to be taxed. The property would, however, be owned entirely by you. Even in cases where there is no written Will, there’s a “Right of Survivorship,” which would mean the property would belong to you (after tax), though the rest of their family would still have a claim to their shares of other assets. Tenants in common, meanwhile, means that you each own a percentage of the property. In this case things are even more complex. If your partner’s Will states that they are leaving their share of the property to you then any inheritance tax owed on it will be paid out of the estate by the executor and the home should be yours. If there is no Will, however, their share will go to their direct relations, meaning that, if you own a home with someone you are not married to, it’s always advisable to make a Will.

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Inheritance Tax on Different Properties

Do I have to pay council tax on a farm?

Agricultural property is often not actually subject to inheritance tax at all, and in cases that it is, it’s generally at a reduced rate. This is known as “Agricultural Property Relief,” and is given on the value of your land. Whether it is available at a rate of 100% or just 50% depends on not only who owns the land, but how long they have owned it for.

What is defined as “agricultural property” for inheritance tax purposes?

To meet the criteria of “Agricultural Property,” the property must be occupied for agricultural purposes and must have been owned for at least two years if the land has been farmed by the owner, or seven years if the land has been let out to another farmer. The land in question must include agricultural land or pasture, woodland, buildings used for livestock or fish, and any residential buildings must be “Appropriate” to the character of the farm. If the property has land set aside for cultivation of food, breeding or grazing and keeping farm animals, it will also help your case. The cases will vary from farm to farm of course, so you might want to do a little more research if you’re a farmer looking into writing up Will.

What happens with paying inheritance tax on properties abroad?

If you live abroad permanently then inheritance tax will only be paid on UK assets (property and bank accounts etc). It will not need to be paid on assets such as overseas pensions, trusts, investments and foreign accounts. Note, however, that the HMRC won’t count you as living abroad if you have lived in the UK for at least 17 of the last 20 years and have had a permanent home in the UK at any time in the last three years.

What is “double taxation relief”?

Your executor might be able to reclaim tax through a double-taxation treaty if inheritance tax is charged on the same assets by the UK and the country where you lived. This essentially exists to stop you from being taxed by two countries. If the country where you were living charges inheritance tax on the same property or gift the UK is taxing, you might be able to avoid or reclaim the tax through double taxation relief.

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The topic is not particularly pleasant or easy. However, hopefully we’ve been able to put your mind at ease a little regarding something many people are either afraid of or simply don’t understand. There are also many ways and means you can use to cut down on inheritance tax, most of which are perfectly legal. That’s a much more complicated topic for another time though!