Can you use your property to avoid inheritance tax? What you need to consider

Mortgage brokers are receiving a growing number of enquiries from homeowners looking for ways to use a property to help them avoid inheritance tax since the government revealed its plans to include pensions in IHT calculations.

Wealth that’s built up under your roof can be released early and passed on to the next generation lowering the value of your estate on death.

But to avoid being stung by a hefty tax bill or saddled with the wrong type of mortgage, it’s important to understand the rules around gifting and the different ways you can release equity first.

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We look at how you can use your property to avoid leaving your loved ones an expensive inheritance tax bill.

How inheritance tax works

Before unlocking cash from your property to gift to your loved ones to avoid inheritance tax, get to know the tax-free allowances available to you and the seven-year gifting rule.

We each have a tax-free allowance of £325,000 known as the nil-rate band. This means that if the total value of your estate is valued at £325,000 or less there is no inheritance tax to pay.

Any portion of your estate worth more than £325,000 is taxed at 40%. Married couples or those in a civil partnership can pass any unused portion of their tax-free allowance to the surviving partner on death which could boost their nil-rate band to £650,000.

When passing a property that you’ve lived in at some point (buy-to-lets don’t count) on to your children or grandchildren, you qualify for an additional relief worth £175,000 called the residence nil rate band. This can also be passed on to your surviving spouse or civil partner amounting to £1,000,000 of tax allowances before IHT is payable.

But, if you’re single without any children and live in a property worth more than £325,000, easily achievable in higher value areas in the country, your estate can expect to attract some IHT.

How does the 7-year rule work?

You can make cash gifts, such as money unlocked from your property, that exceed your nil rate band tax-free using the seven-year rule.

If you live for seven years after giving the gift, no inheritance tax is due payable. But if you die within seven years, some inheritance tax is due.

Here’s an illustration to show how it works in practice:

Daphne, a single lady in her 70s with no children, has a mortgage-free property worth £1 million.

To reduce the value of her IHT liability on death, Daphne wants to release some of the equity in her home to gift to her niece. She makes a gift of £400,000 but dies five years later.

Because she did not live for seven years after making the gift, Daphne's niece will have to pay some inheritance tax on the money which is calculated using what's known as taper relief.

Taper relief only applies to the portion of the gift that exceeds the £325,000 threshold. It reduces the amount of tax payable on that gift but only if they do not die within the first three years of passing on the wealth.

Source: Gov.uk

The portion of Daphne's gift above the nil rate threshold of £325,000 is £75,000. Because she died five years after gifting the cash, the tax liability would be 16% of £75,000 which is £12,000.

If Daphne had lived for more than seven years after making the gift her £325,000 nil rate band would be reinstated in full.

If you die within seven years of making a gift worth less than £325,000, no IHT is due anyway so there's no bill to pay. But, it will reduce the value of your nil-rate band that can be used against the remainder of your estate.

Our "eight ways to reduce your inheritance tax bill" guide explores other options when it comes to the levy.

How remortgaging could help you gift sooner, saving on tax

Since chancellor Rachel Reeves announced in the Autumn Statement that pensions would be included in IHT calculations from April 2027, mortgage brokerage Private Finance has received calls from homeowners looking into their mortgage options as part of their inheritance tax planning.

“People are definitely thinking about using their homes and planning what to do,” said Chris Sykes, technical director at the brokerage. “This is sometimes the children looking into this for their parents, other times it’s the parents and their wealth advisers approaching us.”

Remortgaging your property is one way to unlock your capital to pass on to the next generation, but there’s lots to weigh up says Mr Sykes.

He added: “The older you are the more difficult it is to get a mortgage but there are a lot of specialist building societies out there now who have flexible criteria suitable for older borrowers.”

Here’s some dos and don’ts to bear in mind before remortgaging to gift cash to family:

• Do check when your current mortgage expires to avoid paying early repayment charges.
• Do consider how you’ll afford the repayments if you’re due to retire before the end of the mortgage.
• Don’t neglect your own financial needs later in life – you may need the equity in your home to pay for care.
• Do consider your ability to refinance when your mortgage deal expires if your income in retirement has reduced, a spouse has died or there’s been a loss of mental capacity. Speak to your broker about long-term fixed mortgage rates.
• Don’t forget you can always consider downsizing or remortgaging to an equity release mortgage to repay your mortgage early.
• Do work with a mortgage broker and inheritance tax expert before making a decision.

Equity release: Is it a tax-efficient way to help the next generation?

“Equity release for inheritance tax mitigation can be really attractive,” said Gianpaolo Mantini, chartered financial planner and partner at Saltus. “Especially in the South and the South East where property prices are on average higher.

“It can also be attractive when you’re living in the family home and you don’t want to move but there’s a lot of trapped capital in property.”

Equity release is type of mortgage only available to homeowners aged 55 or older. It’s also known as a lifetime mortgage.

Interest rates are fixed for life, the debt does not have to be paid until the last surviving homeowner dies or moves into long-term care and monthly payments can be rolled up and added to the debt. This makes the loan affordable in retirement.

But by doing so, the interest will build every year and the debt will grow.

Borrowers are usually restricted to loans of up to 40% of their property’s value and interest rates tend to be higher than a standard high street mortgage.

“A lifetime mortgage allows you to give your children an advance on the inheritance they would get in the future,” added Mr Mantini. “And, whilst you are being charged interest on the debt, if your children take that money and use it to buy their own home, that property will rise in value over time as well.”

Downsizing: why selling up sooner could pay off

Selling up and moving to a smaller, cheaper home is another way to free up the equity trapped in your property.

According to removals comparison site Reallymoving.com, downsizers on average buy a property that’s almost £140,000 cheaper than the one they are selling.

Some or all of the cash can be gifted to loved ones and you’re left with mortgage-free property that is cheaper to run and maintain.

You may need to retain some of the money to future-proof your home, such as widening door frames or installing a ground floor wet room, to make it suitable if you become less mobile later in life.