How Your Property Can Affect Your Income Tax

Your family home is important and, after you die, you may want to leave it to your loved ones. But you might also be asking what’s the best way to do this without paying a lot of tax?

Houses often account for the largest chunk of your assets, so they make up most of the amount you can leave tax free.

And with house prices rising, it could take up almost all of the money you can leave without facing Inheritance Tax.

The good news is that new rules mean you can leave more without paying Inheritance tax. But they can be hard to understand. We’ve put together a guide to answer questions you might have about your property and show you what options are open to you.

Downsizing your property

Inheritance Tax occurs if the sum of your personal assets, including property you own and the money in your bank, is worth over £325,000. If you are married, you can combine this total with your spouse, meaning all the assets you own can total £650,000 before you pay tax.

Due to recent rises in house prices, the government has brought in new reforms that have increased the total value of assets you can pass on when you die without having to pay Inheritance Tax.

Recent rules have allowed for an extra £100,000 per person for your property before Inheritance Tax is taken. This means the total can be £425,000 individually or up to £850,000 for a married couple. This is called an additional threshold. The total extra allowed is going up each year to match inflation.

The new nil-rate tax band, the total value of assets you can have before being taxed, now applies to when a person downsizes their home.

When downsizing, you usually move to a less expensive property and therefore miss out on the extra tax allowance you get from your house. To counteract this, you can find out how much money you would have saved from the additional threshold and claim it back. This is called lost additional threshold. To do this, you will need to keep evidence of the sale of the property and evidence that this was your main home.

This is useful if you want to sell a larger, more expensive home to move to a smaller and appropriate home for later life, but don’t want to lose the benefit of tax-free thresholds. It is designed to ease concerns that older individuals would hold onto larger properties for tax reasons.

Working out the lost additional threshold

There are steps you can take to work out how much money you are entitled to. The lost additional threshold shows how much money you could have left tax-free under the new rules and allows you to claim it. It is a difficult process, so here is our guide to understanding how to approach this:

  1. Work out the additional threshold that you could have been entitled to when your house was sold. This is the extra allowance on the amount of money you can leave to your loved one on top of the standard £325,000. It changes each year and as of 2017, it is £100,000.
  2. Once you have this amount, find the value of the house you sold.
  3. Divide the cost of the house by the additional threshold at the time you sold it. This figure can be found on the HMRC website.
  4. Times this amount by 100 to find a percentage.
  5. If you are leaving your downsized home to your family, find the value of this house.
  6. Find the value of the additional threshold available at the date you die. This is easily found on the HMRC website.
  7. Divide the value of the downsized home by this additional threshold amount. Times this by 100 to get a percentage again.
  8. Deduct this percentage from the percentage found in step 3
  9. This gives you a new percentage
  10. Find the additional threshold available at the time of your death (again found on the HMRC website) and multiple by your new percentage.
  11. This gives you the amount of lost threshold that you can then use to increase the value of your assets that are not subject to Inheritance Tax.

This method is complex and can lead to difficulties regarding the additional threshold available at certain times. To be certain of the amount, it is best to contact a Financial Advisor for additional help.

Gifting your house

If you want to leave your home to your loved ones after you die, you could consider giving your home away. There’s usually no Inheritance Tax to pay if you move out of your house and live for another 7 years. If you want to continue living in your property after giving it away, you’ll need to pay rent to the new owner at the going rate. This also helps to pass on money to your loved ones without exceeding the gifting limit and reduces the total value of your estate, reducing tax. If you only give away part of your property or the new owners also live at the property, you will not have to pay rent. You will also have to pay your share of the bills and live there for at least 7 years.

If you die within 7 years of giving away your property, your home will be treated as a gift. This means that the 7-year rule applies and Inheritance Tax will be charged on anything you give away more than £325,000 in the 7 years before your death.

Whatever you choose to do with your family home, it is always best to seek the advice of a financial advisor before making a decision so you can make an informed decision.

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