Ask the expert: Inheritance tax tactics

This week's expert is Chas Roy-Chowdhury

The Ask the Expert column gives readers a chance to have their financial questions answered.

This week, Chas Roy-Chowdhury, head of taxation at the Association of Certified Chartered Accountants (ACCA) helps a your money reader with an inheritance tax (IHT) question.

The reader's mother died leaving a property worth around £575,000 to be split between her sister and three children.

The reader would like to know whether when he calculates the IHT bill, can he deduct the costs of selling his mother's home such as those charged by the solicitor and estate agent?

The expert was also asked to outline some commonly used tactics for reducing IHT.

Chas Roy-Chowdhury writes:

IHT is payable at 40% of the value of the estate over the tax threshold.

The IHT threshold is £300,000 for the 2007/2008 tax year.

So, the value of assets owned at death needs to be totalled, then allowable deductions can reduce the value of the estate before tax is calculated.

Calculations explained

Assets to be taken into account when working out the value of the estate include not just the house, but car(s), bank accounts, shares, pensions, jewellery, collectibles and any other items of value, including a business.

Bills outstanding at the date of death, and any funeral expenses are allowable deductions.

However, sadly, any costs associated with selling a property would not be allowable for IHT purposes.

The executor or administrator is liable to pay any IHT due, before the estate is distributed.

The tax has to be paid within six months of the end of the month in which the death occurred, and interest will be charged on any tax not paid by the due date.

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Tax reduction tactics

Although they do not apply to Mr Godber's situation, there are ways in which IHT liability can be reduced.

Anything left to a spouse is free of IHT, as are all outright gifts and bequests to UK registered charities.

The spouse exemption is also available to civil partners, but not to long-term partners or co-habitees who are not married.

For example, if a husband and wife each had assets worth £300,000 which they had willed to each other, when the first one died, there would be no IHT liability.

When the remaining spouse died though, the combined estate would now be worth £550,000 assuming there had been no change in the meanwhile.

IHT would thus be payable on the excess £250,000 after the tax threshold had been exceeded.

If more than seven years passes between the gift and the death, the gift will be exempt from inheritance tax

But careful use of the basic £300,000 "nil rate band" can significantly reduce IHT liabilities.

If the first spouse to die had in fact left the estate to someone other than their spouse, there would still have been no tax to pay on the first death, as their nil rate band would have covered it.

The remaining spouse would then have the nil rate band available to apply to the value of their own estate, meaning that there would be no tax to pay on that either.

Exemptions

If you die within seven years of making a gift, this "potentially exempt transfer" (or PET) will be exempt at the time of the gift, but becomes liable for IHT on death.

If more than seven years passes between the gift and the death, the gift will be exempt from inheritance tax.

However there are a few exceptions to this, in relation to lifetime gifts.

The following are exempt from IHT even if a death follows within seven years:

• Gifts up to £3,000 in any one tax year, plus any unused balance of £3,000 from the previous tax year

• Small gifts exemption of £250 per recipient per year

• Wedding gifts up to £5,000 to each of your children (including step-children and adopted children)

• Wedding gifts up to £2,500 to each grandchild

• Wedding gifts up to £1,000 to anyone else.

  
  

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.