Why we shouldn’t exempt the family home from inheritance tax

I’m completely bemused by this article in the Times today. It has London’s deputy mayor on housing, Richard Blakeway, saying that one of the reasons older people won’t downsize from large houses is because they “could gain a big profit which would be liable to inheritance tax when they die”.

His solution is to “see if there are ways to protect this cash from inheritance tax” (IHT). This makes absolutely no sense whatsoever.

How much inheritance tax you pay does not depend on the manner in which you hold your assets. When you die, the value of the whole lot is totted up and everything beyond your nil rate band (£325,000, or £650,000 for a couple) is taxed at 40%.

It makes no odds whether your assets are primarily made up of the house you live/die in, equities, other properties, cash, or anything else for that matter (contrary to popular middle-class belief, the fact that an item is so portable that you can hide it from the tax man does not technically make it IHT-free).

So in fact, the best way for anyone to avoid IHT is not to stay in their house, as Blakeway appears to suggest, but to sell it as soon as it is remotely feasible, downsize and give all the proceeds from the deal to their kids. That way, under the seven year rule, they should get to pass on a whole pile of money tax free.

People don’t refuse to downsize because of IHT. They refuse to downsize because they don’t want go through all the bother of moving house. Given this, what on earth is Blakeway trying to say? Answers below if you have them.

Making gains from primary homes both be capital gains tax-free and IHT-free would not only offer yet another break to the property-owning classes, it would also compound rather than solve any of our problems.

After all, if you knew that your house would have this kind of double tax-free status, surely you would make even more effort to leverage yourself to the hilt to pay for a whopper of a house than most people do already? Nuts.

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36 Responses

  1. 30/05/2014, David Webb wrote

    Well, in fact, IHT should not exist for wealth derived from capital or labour. But in the absence of a land value tax, landed property is the only type of wealth that definitely should have an IHT – and I would argue the entire capital appreciation of the unimproved site should be captured in IHT to prevent land value appreciation, with good social results.

    • 02/06/2014, Rambler wrote

      I support Merryn on this. IHT is a benefit to people who have not worked to obtain the wealth and as such there should be no exemptions on IHT. If someone has built their wealth on their own achievements then tax on their labours should not be high, but the recepients from their estate had no hand in this wealth generation and so should not obtain any tax exemptions. Anyway there are many ways to actively reduce IHT through planning, it is therefore upto the wealth creators to decide if any tax reductions for their benefactors should be sought.

  2. 31/05/2014, mr clyde wrote

    I agree, with properly applied Income tax, CGT and VAT, IHT becomes an unfair double tax. (NB. properly applied CGT and VAT would also provide a fair and efficient LVT, although Greg will disagree). In answer to the original question, what Blakeway is trying to say (to Londoners in particular) is ‘vote for us and somebody else will pay your taxes’.

    • 02/06/2014, Greg wrote

      I agree wholeheartedly with Merryn, it would compound the problem, increasing demand and house prices, with those already owning property being the main ones benefitting – absolutely crazy idea! But we all know that The Conservative Party have been trying to get rid of IHT for years.

      Mr Clyde, CGT and VAT is not a Land Value Tax, the difference being that CGT would include improvements to buildings. I’m not sure how VAT comes into this? Do you mean the VAT on labour and materials?

      A Land Value Tax would be the fairest form of property taxation and might actually encourage retired people to downsize, freeing up larger, arguably underused and inefficient homes. It could be argued that a LVT could replace (or partly replace) IHT but given the current vast wealth inequality and budget deficit I would be inclined to replace Council Tax and Stamp Duty with a LVT and keep IHT but with the threshold at a higher level.

  3. 02/06/2014, Clive wrote

    Tax, whether it’s IHT or any other tax, isn’t the cause of any of our housing problems and neither will it be the solution. That’s simple – build 100,000s of thousands of homes per year, problem solved.

    As to people inventing yet more ways for the government to tax us – crazy !.

    re Rambler “there should be no exemptions on IHT” – most of the population is exempt. Be interesting to see how it plays ‘down the pub’ to tell everybody they’ll be paying tax when they inherit even modest wealth.

    • 02/06/2014, Greg wrote

      Clive, I disagree. Our current property taxation is one of the major causes of our broken housing market:

      Stamp Duty creates distortions in the market and effectively means the purchaser is paying for the Capital Gain of the vendor.

      Council Tax banding means that someone in a modest 4 bed detached pays the same as someone in a mansion – it is based on the buildings, not the value of the land encouraging inefficient land use. It is not paid on development land nor buildings outlined for demolition, so there’s no incentive for developers to build or finish homes to release.

      Buy To Let has many unfair tax advantages over the First Time Buyer including repairs and maintenance – receipts for which are often never checked by HMRC – and CGT is often avoided.

      So I believe you are wrong. Replacing many of our current taxation with a Land Value tax will solve many of the problems, as will scrapping Buy To Let and considering increasing taxation on second homes and homes purchased by foreign investors to park money. LVT would be easier to administer and harder to avoid/evade.

      Yes, of course we need to build more houses too.

      • 02/06/2014, Clive wrote

        Greg

        How does LVT solve anything. Let’s say it was 1% of house value and we have an elderly person sitting in a £1m house (very likely in the SouthEast and it needn’t be a big house). So, we hit them with a £10K bill each YEAR. They can’t pay that. Is society in general, and politicians in particular, going to turf that person out of their house ? I think not. Bill sill simply run til they die. Result: no extra tax raised for a decade/two.

        Even if they did move out, how does that solve anything. One little old person moves out, one rich young thing moves in. No increase in housing availability, no reduced demand for housing. Imo, solves precisely nothing.

        Plus, the thing politicians always forget, the law of unintended consequences. So, we put a squeeze on housing. Where’s all the money going to go ? Nobody knows

        What most people want here in the South East is massively more housing, which will necessarily bring the prices down. Even if it was all bought by BTL merchants, once supply exceeds demand rents will come tumbling down, bring prices BTL types are willing to pay tumbling down with it.

        Build more houses !

        • 02/06/2014, benji wrote

          @ Clive

          Happy to help you with this.

          Firstly, you are arguing against transitional arrangements, not the proposal itself. (The proposal being to end the massive State subsidy freeholders currently enjoy. The right to exclude as granted by the State is the only reason location has any value. Freeholders should therefore pay the full market rate to those who created it’s value. Anything else is a defacto subsidy.)

          This can easily be dealt with by roll up and deferment. So no turfing out.

          Subsidies cause deadweight losses i.e over consumption and mis-allocation. Therefore if you end the £200bn per year subsidy residential freeholders currently enjoy, you will get costs aligned with needs. So, poor widow who doesn’t need her family home will be better off downsizing and a family who can afford to pay the LVT(which is the same as a mortgage or rent minus the improvements) can now afford to move in.

          Secondly, if that subsidy where to end, we know precisely the effect on taxes on Income and Capital.

          We could scrap VAT, NIC’s and institute a flat 20% on all income.

          This would put an extra £11,000 in the pocket i.e net, of the average UK household.

          Also, the subsidy would now no longer be capitalised into selling prices, so we would expect to see a reduction in HP’s of around 50%.

          Together, this would improve housing affordability for an average UK household, as a ratio of discretionary income, by four fold.

          You won’t get a four fold increase(if any) improvement, no matter how many houses you build.

          And, as a bonus, the reduction in deadweight costs by lowering taxes on capital formation would expand GDP.

          Some economists who have calculated this put these costs as nearly 50% GDP. So the gains would be certainly worthwhile, to say the least.

          Thirdly, each freehold title is a monopoly, so the normal rules of supply and demand don’t apply to housing.

          Indeed, once you factor in the effects of agglomeration, in London and the SE aggregate HP’s would rise by building more homes.

          Which is only common sense if you think about it.

          See here for more info.

          http://kaalvtn.blogspot.co.uk/p/index.html

          • 02/06/2014, Greg wrote

            Thanks Benji – yup and LVT would indeed help – Clive, I also believe BTL should be scrapped – all it does is create additional demand and force up housing costs for all.

            • 02/06/2014, benji wrote

              We only all need to be treated the same with no special privileges.

              BLTers are only doing the same owner occupiers and banks are.

              We should all pay the same. Then the market will function efficiently. At the moment the dice is loaded in favour of those with the largest Land assets, so we don’t have a free market.

              A Mr Churchill observed, what we have is the Mother of all monopolies.

              • 02/06/2014, Greg wrote

                I agree about all being treated the same, that’s why it’s not just down to tax it’s also about “interest only” mortgages based on projected rental income rather than purchaser’s income.

                One could argue that an ordinary self-employed purchaser (with no intention to let) should still be able to get a massive interest only mortgage for a house based on the potential rental value because he/she could always let it out!

                As BTL mortgages can still be obtained by people with no intention to let them out – often to live in themselves, re-develop or to let for holidays – BTL is basically a continuation of sub-prime lending fuelling demand and prices of houses.

                • 03/06/2014, benji wrote

                  True.

                  But, if you did have a LVT, HP’s could never rise above the value of bricks and mortar(only about 33% of a property’s value on average in the UK).

                  So, given that, BLTers current advantage would be nullified. They would only be borrowing more, to pay more LVT.

                  Sounds good to me. I’ll be paying less in other taxes/higher Citizens Income.

                  • 03/06/2014, Greg wrote

                    I totally agree about LVT instead of many of our current forms of taxation – I think it would be most acceptable to replace Council Tax & Stamp Duty in the first instance, however I cannot see how that would address the current tax and interest-only advantages of BTL mortgages unless LVT was to replace ALL taxation which is never likely to happen, and would arguably still result in growth in inequality and social segregation – we might still need to consider income tax and inheritance tax to address these issues but with the vast majority only paying LVT.

                    With LVT replacing Council Tax and Stamp Duty, BTLetters would still have the upper hand over FTBs because of being able to offset so many things for tax – as things stand they would be able to offset the LVT against their tax bill and still get the interest-only mortgage, and as the tenants would not be paying Council Tax and the LVT paid by the landowners being offset, rents and HP would most probably increase further.

                    • 03/06/2014, benji wrote

                      LVT should replace all taxation on Capital formation.

                      I’m not sure quite how you think inequality would widen.

                      The top 1% of all households own 50% of all land by value.

                      Simple maths, they would be liable for an extra £100bn to the exchequer.

                      Average UK household, £11,000 better off net.

                      Mortgage payments reduced by 50%.

                      And of course, you’ve got the alleviation of deadweight losses.

                      Some economists who have taken the trouble to calculate these, put the total figure at nearly 50% GDP.

                      It’s a win-win for everyone, except the Duke of Westminster et al.

                      All you arguments and queries against LVT dealt with here

                      http://kaalvtn.blogspot.co.uk/

                      Leave a message, if you’ve got any more questions.

                  • 03/06/2014, Clive wrote

                    benji

                    YPP site seems long on ‘this’ll solve all our problems’, but very short on numbers.

                    btw think the guys shown are a bit old to be the Young People’s Party.

                    • 03/06/2014, benji wrote

                      http://kaalvtn.blogspot.co.uk/p/valuations-and-potential-lvt-receipts.html

                      Look at this whole site carefully. All in detail.

                      If you still think there is anything missing, please leave a message. You will get a reply.

                      Any criticisms or thoughts, again please leave a message.

                      Young people are at the bottom of our State backed Ponzi scheme. So if any change is going to happen, it we be with that generation.

                      Enlightened oldies are, of course more than welcome to join the revolution. If you’ve got the time :)

                  • 03/06/2014, Greg wrote

                    Re possible inequality and social segregation – some incomes are so high and it would depend on how much of those high incomes was spent on housing/land – it could result in less social diversity in high land value areas with the poorer members of society forced to live in less desirable areas. I realise that’s already the case but it could exacerbate the problem. Theory is one thing, practice is another. However I’m generally in favour of LVT – we should definitely be taxing land rather than buildings – how far we go at replacing other taxes with the LVT I’m currently undecided. LVT is certainly fairer than most other forms of taxation and encourages efficient land use, it’s just the potential social problems that would need to be considered.

      • 02/06/2014, benji wrote

        Don’t buy into the build, build, build propaganda being spun by those with invested interests.

        http://www.conservativehome.com/thecolumnists/2012/12/andrew-lilico-the-2011-census-data-confirm-once-and-for-all-that-the-notion-of-a-housing-shortage-in.html

        We already have a very inefficient allocation of property resources. 25 million empty spare rooms for example.

        Building more homes on green land will make things even more inefficient (although a lot more good quality high rise in Central London wouldn’t hurt anyone apart from Prince Charles).

        We need high rates of agglomeration, a high recycling rate of existing sites, and a level playing field for the regions out side the SE.

        A LVT would sort that all out, with out the need to build a single home on green land.

  4. 02/06/2014, Ellen12 wrote

    I suppose the argument against charging IHT is if an adult child lives in the home. Sometimes they have even been the carer for a sick and elderly parent. It does not seem fair to chuck this person out of their home when their parent dies because they couldn’t afford the tax on the house. Often these carer has compromised their own career to care for a parent and their contribution to government saving may also be considerable.

    This is another problem with homes being treated entirely as investments.

    • 02/06/2014, Greg wrote

      I agree Ellen – I have a friend who this happened too, and I should imagine it’s likely to be an ever increasing problem as people have children later in life and offspring are living with their parents much longer as they cannot afford to buy a place of their own.

      … also people cohabiting who decide not to marry or have a civil partnership. My father cohabits – has done for past 25 years – the house is owned outright by his partner. I’m not sure if they have made any will provisions but the law doesn’t recognise their relationship. It would be unfair to expect him to pay IHT and move at his age.

  5. 02/06/2014, rumbled wrote

    Taxes must be simplified so that they are simple.

    IHT for all and at 10%. No exemptions .No avoidance. For simplicity have a start at 1K.
    People will not need to visit lawyers to reduce IHT by means of complex legalities, and they will be spared the propaganda of the Financial Industry.

  6. 03/06/2014, Angela wrote

    I agree with Ellen, too. A family home should be exempt from IHT when a beneficiary is living in the property. The tax could be collected on any subsequent sale of the house.
    Simple and just.

  7. 03/06/2014, Ralph wrote

    Whenever you look at any major proposal to change the tax system, if you scratch the surface of it you will naturally find a person or a body of people with a personal vested interest. Of course usually it is the Government, as the present proposal to liberalise how pensions are taken clearly demonstrates (i.e. more tax now and damn the consequences later).

    The tax system is not fair and can never be. After all, why should someone who makes more money pay more tax if the aim is simply to be fair, as everyone receives the same benefits from the revenue that’s collected don’t they? (actually the tax-payer generally gets less in practice!). The answer of course is simply because they can afford to do so but it doesn’t make the system fair does it?

    With this in mind I don’t see how Benji’s proposals will make the overall system any fairer and the comments about ‘subsidies’ only really hold any credibility if you look at this particular aspect of the tax system in isolation, rather than the tax system as a whole.

    Benji’s proposals sound sensible to me if we were building a new tax system but we aren’t are we? The consequences of these proposals would most likely have a very detrimental short-term (?) impact on people who are already bearing a significant part of the tax burden and who have planned their lives around a tax system that has some fundamental long- term principals. What would most certainly be un-fair is to introduce any major change that would hit this particular group of people the hardest of all.

    Changes like those proposed here would therefore have to be factored in over a very long period – possibly generations.

    • 03/06/2014, benji wrote

      Not building a new tax system. Vastly simplifying it. Here.

      http://kaalvtn.blogspot.co.uk/p/current-and-proposed-taxwelfare-systems.html

      At you can see, there is no “robbing Peter to pay Paul”. Everyone pays the same flat rate. No thresholds, no exemptions, no re-distribution.

      Tolley’s tax guide reduced from 17,000 pages to a couple of dozen.

      LVT is really the only fair way of collecting Government revenue. The value we create together should only pay for the services (or Citizens Income) we share together.

      You chose where you live, so unlike taxes on Capital, you chose your own liabilities. No coercion.

      LVT=3.5% charge on today’s selling prices=26 council tax bands at 20% apart.

      http://kaalvtn.blogspot.co.uk/p/valuations-and-potential-lvt-receipts.html

      Simple maths, anyone whose total household income (excluding benefits) is 10% or more of their homes value would be better off.

      So for an average UK household, this means £11,000 in their pocket.

      Any thoughts or queries, please leave a message on the site.

      • 04/06/2014, Clive wrote

        benji

        OK, I buy myself a £500K house. LVT at 3.5% is £17.5K per year. Ouch, but I pay less/no VAT and NI, so I’m OK with that as you say I won’t be out of pocket.

        What happens if I lose my job ? Either I’m going to need the LVT to be cancelled, or the benefits system to pay me £17.5K/yr (£350/wk) plus my living expenses. Will it do that ? Seems to add a benefits system re-write to the tax system re-write.

        Second, suppose I keep my job. Stay in the house a few years, get an offer on the house of £600K (heh, it’s a nice area, new shops/schools opening). Do I get to keep the £100K profit ? If so, seems to go against your earlier comment of “HP’s could never rise above the value of bricks and mortar”

        If I don’t keep the £100K, who gets it ?

        • 09/06/2014, benji wrote

          75% of UK households would have no LVT liabilities net of benefits.

          Let’s take you example. It’s a reasonable assumption to make that someone in a £500,000 has 20% equity. One part-time working partner and two children. Therefore gross household income of £100,000.

          They are currently paying around £54,000 in taxes, (benefits netted off).

          Under 3.5% LVT, they would be paying total tax of £23,000. So £31,000 better off in their pocket. (again benefits netted off).

          Also historic mortgage interest rates in the UK seem to be around 6%. So they might be paying >£25,000 per year mortgage costs.

          Under LVT, for new buyers, we’d expect that to half.

          So discretionary income(in your pocket) rises from £25,000 to £65,000.

          So that’s a whopping £40,000 per year in your pocket.

          Given that LVT is already privately collected by Banks and landlords who would show you no mercy if you defaulted, I’m sure out of that extra £40,000 you could save/ insure for a loss of job.

          Or you could move.

          Or you could except roll up and deferment.

          Either way, on a cost/benefit analysis, it’s a no-brainer, I’m sure you’ll agree.

          • 10/06/2014, Clive wrote

            benji

            Doesn’t seem much point me trying to argue your figures, as they come mostly from your assumptions.

            Few points

            1) I don’t see people in £500K houses (and there are a lot of them in the South East) are going to be £40,000/yr better off, with no mention of who’s going to be worse off.

            2) Answer to my question of “What happens if I lose my job ?” seems to be – expect no help from the state. That’s unacceptable.

            3) I notice you didn’t answer my other question about who keeps the £100K (rise in house price value) and how you reconcile that with your comment of “HP’s could never rise above the value of bricks and mortar”.

            No-brainer ? Nope.

  8. 04/06/2014, Ralph wrote

    The simple fact of the matter is that your change cannot leave the taxman out of pocket and so there will be winners and losers. It’s the losers who will need to be convinced.

    Sounds like you are proposing a tax increase on retired people – good luck with that one!

    • 09/06/2014, benji wrote

      The only losers are those who’s gross household income is <10% of their home's value.

      And that's only a short term transitional loss.

      Total deadweight losses in the UK are around 50% GDP. LVT eliminates those losses.

      In the long term, only banks, large landlords, and the idle super rich have anything to fear. For 99.9% of us, we are better off.

  9. 04/06/2014, Midvaag wrote

    The 7 year rule allows owners of huge wealth to pass it on early to their children without inheritance tax. They just retain a small proportion – still a lot of money by normal standards – to live off. Eg the “small” house on a small area of a large estate. By contrast the hard working middle classes who cannot afford to pass on their wealth early get hit with 40% tax over £330K. Fairness would dictate that there should be a limit on what can be passed on under the 7 year rule or inheritance tax should be scrapped altogether.

    • 04/06/2014, Clive wrote

      I suspect large estates use techniques other than the simple 7 year rule to avoid IHT. If they used the latter, the estate could be wiped out by one accident (e.g. car crash killing the owners inside the 7 years).

      Also, what’s “fairness” got to do with tax ? Governments work on the basis of taking from those who have it, regardless of “fairness”.

  10. 04/06/2014, NeutronWarp9 wrote

    I have scanned through these contributions and conclude that the current arrangements are probably best by virtue of the fact that all the suggested alternatives produce more problems than they solve or are so dull as to represent a waste of electronic ink.
    As for the current taxation system. Complicated? Not really. Fair? Generally yes if adequately reviewed. Predictable? Reasonably so.
    The biggest danger, of course, is the apparently mad zealot who seems obsessed with the notion that he or she is correct and it is his or her destiny to drive ‘their’ changes through. Egotists like Gove, IDS and Lansley are dangerous with their deluded, ill-thought out ideas. Take note benji. See attached hyper-link…

    • 09/06/2014, benji wrote

      If they are so ill thought out or deluded, it should be pretty easy for you point out why. Making personal attacks instead make me suspect you can’t.

      Says more about you methinks :)

  11. 07/06/2014, Beta Adjusted wrote

    Hmm, via a mechanism involving a reversionary lease, you can legally eliminate all IHT on your primary residence. Hence it does make sense to hang onto the big house and pass it on in this way. Its always worth spending money on proper tax advice on these issues, as the law presents many loopholes that can be used to your advantage if you have good advice; its worth spending money to speak to a tax specialist QC barrister as these are the real exports on the law; solicitors are hit and miss, as are accountants.

  12. 10/06/2014, mr clyde wrote

    Benjii – Let me. If you draw up a distribution of the proportion of personal wealth held in property against total personal wealth you will find that the areas of population that will be least affected by LVT are those that own no property and then the very wealth (hereditary landowners excepted) whose other assets far outstrip their relatively modest housing assets. The people who will really suffer are those that own a house and not much else. LVT might have been a good idea in a feudal, agrarian economy (circa Adam Smith), but not in a modern complex mixed one.

  13. 22/06/2014, at wrote

    “You should pay tax on inheritance because you did not work for it”, this is absurd. What you inherit is a gift (from your family, usually), so what does “working for it” have to do with it? Your family has already paid multiple layers of tax on whatever has been passed on to you, this is just another junction point, an excuse, for the greedy government to come in and tax some more.

    Merryn is right, cash is almost untraceable, so selling the house once it exceeds the threshold and giving the cash to your kids is the better option.

    What Merryn did not account on is that you do not really trust your kids with your cash, after all, you may live another 10 or 20 years, and your kids (or their wives/husbands) may have different ideas. It will have to be structured in such a way that the cash remains in your control 100% and yet not liable to tax. Maybe a joint account where the kid does not know it although he could find out if he wanted.

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