Gifting and the Seven Year Rule - How to Reduce Inheritance Tax

How lifetime gifting reduces inheritance tax

When you give an asset away during your lifetime, it is treated as a potentially exempt transfer (PET). Survive seven years from the date of the gift, and the value falls entirely outside your estate - no inheritance tax is payable, regardless of the value of the gift.

Die within seven years and the gift may still attract IHT - but the rate is reduced on a sliding scale once you have survived more than three years. This sliding scale is called taper relief.

Lifetime gifting is one of the most effective IHT planning strategies because it directly reduces the value of the estate at death - provided the seven-year clock has time to run.

The seven year taper relief table

The IHT rate on a failed PET tapers as follows, based on how long you survived from the date of the gift:

The practical implication is straightforward: the earlier you start gifting, the more effective it becomes. Taper relief only applies on the portion of a gift above the available nil-rate band at the time of death.

The annual gift exemption

Each person can give £3,000 per tax year free of IHT, regardless of the seven-year rule. The exemption can be carried forward one year if unused - so up to £6,000 can be gifted in the first year of use.

For a married couple, that combines to £6,000 per tax year, or £12,000 in the first year using the carry-forward. Over a decade, that represents £60,000 to £120,000 passed entirely free of inheritance tax with no seven-year clock to worry about.

The small gifts exemption

You can give up to £250 per person per tax year, to any number of different people, completely free of inheritance tax. The small gifts exemption cannot be combined with other exemptions to give the same person more than £250.

Wedding gifts

Gifts made on the occasion of a marriage or civil partnership are exempt from IHT up to specific limits - £5,000 from a parent, £2,500 from a grandparent or one of the parties to the marriage, and £1,000 from anyone else. The gift must be made in contemplation of the marriage and conditional on it taking place.

Regular gifts from income

Gifts made regularly out of surplus income are exempt from IHT without any upper limit, provided they are genuinely from income and not capital, the giver maintains their usual standard of living, and the gifts form an established pattern.

Keeping clear records - showing income, expenditure and the surplus actually available - is essential. The exemption is one of the most powerful and underused in the IHT system. For families where income comfortably exceeds expenditure, it can move very substantial sums out of the estate over time with no seven-year clock.

Gifting property - important considerations

Gifting property starts the seven-year clock but creates complications. If you continue to live in the property without paying market rent, the gift-with-reservation rules treat the property as still inside your estate - so no IHT is saved.

You must pay full market rent to the new owners (the children) if you continue to live there. The rent itself is taxable income for the children and uses up some of the IHT benefit. There are also capital gains tax consequences when the children later sell.

Property gifting works in narrow circumstances only. Professional advice before transferring a property is strongly recommended in every case.