How Does Inheritance Tax Apply to Gifts?

When you make gifts during your lifetime, they can affect how much Inheritance Tax is due when you die. Most gifts become exempt from Inheritance Tax if you survive for seven years after making them, but the rules are more nuanced than many people realise. Understanding which gifts count, which are...

What Counts as a Gift?

A gift can be money, property, possessions or anything else that has value. Importantly, a gift must reduce the value of your estate.

If you sell an asset to someone for less than it's worth, the difference in value counts as a gift. For example, if you sell your house to your child for £200,000 when it's worth £350,000, you've made a gift of £150,000.

Potentially Exempt Transfers and the Seven-Year Rule

Most gifts you make during your lifetime (except those covered by specific exemptions) are called "potentially exempt transfers". This means the gift only becomes fully exempt from Inheritance Tax if you survive for seven years after making it.

If you die within seven years of making the gift, it may be subject to Inheritance Tax depending on the total value of gifts you made during that period.

How Inheritance Tax is Calculated on Gifts

When working out whether tax is due on gifts, you need to:

1. List all non-exempt gifts made in the seven years before death, starting with the oldest first

2. Keep a running total of their values

3. Check where the running total exceeds the £325,000 threshold (which remains at this level from 2021 to 2026)

You'll pay tax on the part of any gift that took the running total over the threshold, plus any gifts made after that point.

Worked Example

Masood died on 1 June 2021. In the seven years before his death, he made the following non-exempt gifts:

23 August 2014: £150,000 (running total: £150,000)
12 December 2014: £100,000 (running total: £250,000)
21 July 2015: £50,000 (running total: £300,000)
15 March 2017: £30,000 (running total: £330,000)
3 June 2019: £17,000 (running total: £347,000)
6 January 2021: £10,000 (running total: £357,000)

When the March 2017 gift is added, the running total exceeds the £325,000 threshold. Inheritance Tax is due on that gift and all later gifts.

However, for the March 2017 gift, tax is only payable on £5,000 (the amount that brought the total above £325,000), not the full £30,000.

Gifts That Are Always Exempt

The following gifts are exempt from Inheritance Tax and don't count towards the £325,000 threshold:

Assets passed to a spouse or civil partner – these are completely exempt
Gifts to qualifying charities – the charity must qualify under English and Welsh law (or equivalent in Scotland or Northern Ireland) and be managed by fit and proper persons
Gifts to national bodies – such as The National Trust or The National Gallery
Annual exemption – gifts of up to £3,000 in any tax year
Small gifts – gifts of £250 or less to any one person
Wedding and civil partnership gifts – within specified limits
Regular gifts from income – payments made as part of your normal expenditure and from your income (not capital)

If you leave 10% or more of your net estate to charity, the Inheritance Tax rate on your estate is reduced from 40% to 36%.

Gifts to UK political parties are also exempt, provided that at the last general election before the gift, the party had at least two members elected to the House of Commons, or one elected member and received at least 150,000 votes.

Gifts with Reservation of Benefit

Not all transfers count as genuine gifts for Inheritance Tax purposes. If you give something away but continue to benefit from it, it's called a "gift with reservation of benefit" and is not exempt.

A common example is transferring ownership of your house to a relative while continuing to live in it without paying market-rate rent.

If you continue to use the gift in the seven years before you die, it counts as part of your estate regardless of when you gave it. It's taxed at its market value at the time of your death as if you still owned it.

However, if you later had to move back into a property you'd given away due to unforeseen changes in circumstances owing to old age or infirmity, the gift with reservation rules would not apply.

When the Reservation Ends

If a gift with reservation stops being used by you, it becomes a potentially exempt transfer from that date, and the seven-year clock starts then.

For example, David put his house into his children's names in 2011 but continued living there until 2013, when he moved into a nursing home. The gift became a potentially exempt transfer in 2013 (when he moved out), not 2011. When David died in 2021, more than seven years had passed since the gift became potentially exempt, so no Inheritance Tax was due on it.

Important Points to Remember

Gifts always use up the Inheritance Tax threshold before any other assets or property in the estate. You must value gifts based on what they were worth at the time you gave them, not at the date of death.

Tax on a gift with reservation is usually paid by the person who received the gift. If tax remains unpaid 12 months after death, the personal representative (executor) of the estate may have to pay it.

Sources

Work out Inheritance Tax due on gifts

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.