How to pass your home onto your children: Navigating the UK housing market and inheritance tax

Leaving a family home to your children is a long term plan for many UK homeowners. It’s not just about handing over a property; it’s about ensuring your loved ones have a secure foundation for their future. However, navigating the UK housing market and its intricate relationship with inheritance tax can be challenging. In this article, we’ll explore the most cost-effective ways to pass your home on to your children while considering the nuances of UK inheritance tax.

Understanding the UK housing market

Before delving into inheritance planning, it’s essential to grasp the dynamics of the UK housing market. The property market can be highly variable and influenced by factors such as location, property type, and economic conditions. Here are some key points to consider:

Property valuation:

The value of your home plays a crucial role in inheritance planning. Properties in London and the South East are often more expensive than those in other regions, which can have a big impact on the overall inheritance tax liability.

Property type:

Different property types, such as flats, houses, and apartments, can have varying market values. Additionally, leasehold properties and properties which include a share of the freehold may have different rules or covenants attached in relation to inheritance and resale.

Market trends:

It is also important to keep an eye on property market trends. House prices can fluctuate over time, impacting the value of your assets.

Inheritance tax in the UK

Inheritance tax is a tax on the estate (the property, money, and possessions) of someone who has passed away. It’s essential to understand how inheritance tax works, as it can significantly affect the value of the estate that you leave to your children and may leave them with an unexpected tax bill to pay.

As of September 2023, the current thresholds and rates for inheritance tax are as follows:

Thresholds:

In the UK, everyone has a tax-free allowance known as the “nil-rate band.” This threshold is currently £325,000 per person. If your estate is valued at less than £325,000, then there is normally no inheritance tax to pay.

Residence Nil-Rate Band (RNRB):

Introduced in April 2017, the RNRB applies to individuals who leave their main residence to their direct descendants (children or grandchildren) and means that the estate may be entitled to a higher tax-free threshold. The current RNRB is up to £175,000 per person and the threshold increases every year in line with inflation, based on the Consumer Price Index.

Combined allowances:

For a married couple or a couple in a civil partnership, the nil-rate band and RNRB allowances can be combined, potentially allowing for a total tax-free allowance of £1 million in total.

Tax rates:

The standard inheritance tax rate is currently 40% on any estate value which exceeds the available thresholds. So, for example, if your individual estate was worth £500,000 and RNRB did not apply, inheritance tax would be liable on the amount over the  £325,000 tax-free allowance. In this case, £175,000. This means the inheritance tax bill would be £70,000. A sizeable sum!

Cost-effective ways to leave your home to your children

Now that we’ve covered the basics of the UK housing market and inheritance tax, let’s explore some cost-effective strategies to leave your home to your children while minimising the inheritance tax liability.

Make a will:

A well-drafted will is the foundation of any effective inheritance plan. It allows you to specify how you want your assets, including your home, to be distributed after your death. Without a will, your assets may be subject to intestacy rules, which might not align with your wishes.

Take advantage of the RNRB:

If your estate includes a main residence, ensure you’re making full use of the RNRB. Leaving your home to your children or grandchildren can help reduce the overall inheritance tax liability and in some cases will mean there is no inheritance tax to pay at all.

Consider gifting:

One way to reduce your estate’s value for inheritance tax purposes is to gift assets, including your home, during your lifetime. However, be mindful of the seven-year rule. If you survive for at least seven years after making the gift, it will generally be exempt from inheritance tax. If not, the gift may be subject to tapering relief.

Trusts:

Setting up a trust can be a strategic way to manage your estate and reduce inheritance tax. You can transfer your home into a trust, retaining some control while reducing the estate’s value. However, trusts can be complex, and professional advice is essential.

Life insurance:

Consider taking out a life insurance policy that pays out a sum on your death. This payout can help cover any inheritance tax liability, ensuring your children receive the full value of your home.

Seek professional advice:

The UK’s tax laws are complex, and they evolve over time. Consulting a qualified financial advisor or solicitor with expertise in inheritance planning is crucial to develop a tailored strategy that aligns with your goals.

Leaving your home to your children is a significant decision that requires careful consideration of the UK housing market and inheritance tax implications. By understanding the market, making the most of available allowances like the RNRB, and employing effective strategies such as gifting or using trusts, you can minimise the inheritance tax burden and ensure a more cost-effective transfer of your property to your loved ones. Remember that tax laws can and do change, so it is essential to stay informed and consult with professionals to create an inheritance plan that best suits your family’s needs and financial situation.