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What is the 7 Year Rule in inheritance tax?

20 November

What is the 7 Year Rule in inheritance tax?

In our experience from talking to our clients, there is a widespread awareness of the “7 Year Rule” applicable to Inheritance Tax, but many misunderstand the application of the Rule.

In simple terms, where there is a potential liability to Inheritance Tax lifetime gifts can be made with a view to mitigating the liability.

What is tapering relief?

Tapering relief means that the amount of Inheritance Tax decreases on gifts made three to seven years before the date of death. The principle of the 7 year rule is known as taper relief.

How does the 7 year rule work?

Let us consider a single person who has an estate of £500,000, for example. They have no children of their own so they have made their Will in favour of their nephews and nieces. If they do nothing, then when they die, the first £325,000 of the estate will pass to the nephews and nieces free of tax.  The balance of £175,000 will be subject to Inheritance Tax at 40%. So, the tax bill will be £70,000 and the nephews and nieces will receive £430,000 after the tax has been paid. 

If the person wanted to try and mitigate the tax liability, then they could give £175,000 to their nephews and nieces during their lifetime. However, if they were to die within seven years of making the gift then the £175,000 would still be classed as part of their estate for Inheritance Tax purposes on their death. If they survive the gift by seven years or more then the £175,000 gift passes outside of their estate leaving them with a reduced estate of £325,000. On their death, after seven years, there will be no tax to pay on the £325,000 as this is equivalent to the nil rate band.

When does the tapering relief apply?

Many clients wrongly assume that a tapering relief applies if a person who makes a gift dies more than three years after making the gift but less than seven years. This tapering relief only applies if the gift which has been made during the person’s lifetime was more than their nil rate band. In other words a single person with no children must give away more than £325,000 for the tapering relief to apply if they die within seven years of making the gift. 

Does the 7 year rule relate to care home fees?

Another common misunderstanding about the 7 Year Rule is that it applies in situations where a person is moving into residential care and the local authority is assessing that person as to their ability to pay for their own care fees. The 7 Year Rule is simply a rule which relates to gifts made with a view to mitigating Inheritance Tax liability.

Our Private Client, Wills and Trusts team can assist with enquiries dealing with the 7 year rule. Give us a call on 0114 249 5969 if you need advice.