We have two properties however our property is value beneath £1M, can we cross all of it on inheritance tax free?

Can we leave two houses to our children without them paying inheritance tax?

The value of our estate falls within the £1million combined allowance for a married couple, so would our entire estate pass tax-free to our children? V.F, via email

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Harvey Dorset, of This is Money, replies: Inheritance tax is levied at 40 per cent on estates above tax-free thresholds.

The standard allowance, known as the nil rate band, is £325,000 for an individual. If you pass on your own home to a direct descendant, an extra residence nil-rate band can be used of up to £175,000 for its value. This creates a maximum tax-free allowance of £500,000 for an individual.

Married couples and those in civil partnerships can transfer any unused allowance to each other, which effectively means a potential combined inheritance tax-free sum of £1million.

Inheritance tax thresholds have been frozen since and over time their real value has been eroded by inflation. Rising asset prices, such as property values and stock market gains, have pushed more people into having an inheritance tax liability.

On top of this, pensions are set to be dragged into the inheritance tax net from 2027.

What this means is that many people will find their estates are worth more than their allowances, even when accounting for the nil-rate band, residence nil-rate band and the spousal transfer element.

This is Money spoke to two financial advisers to find out where you stand.

Lisa Caplan, chartered financial planner and director of advice and guidance at Charles Stanley Direct, replies: Your question is ‘would our entire estate pass tax-free to our children?’. The short answer is quite possibly, but it depends largely on the overall value of the estate on second death and the valuation of the properties at that point.

Under current rules each of us is given a nil-rate band for IHT which is currently £325,000. If you give away your home to your children (including adopted, fostered or stepchildren) or grandchildren, that threshold can increase to £500,000. 

If you have two homes, you may be able to choose which of them is used for the purpose of this additional ‘residence nil rate band’ (RNRB).

If you are married or in a civil partnership, your estate will pass inheritance tax exempt to the other person on your death, if this is your wish. Your spouse will then inherit all or any of your remaining nil rate band – taking into account any gifts you have made to anyone else. This means that the combined threshold for a couple can be as much as £1million.

So, provided your estate planning is set up this way and your two homes fall within the overall £1m threshold, there is potentially no inheritance tax to pay. However, most people have other assets besides property.

The calculation of an estate involves adding up everything – cash, investments, business interests, and items such as antiques and jewellery. If the total estate valuation exceeds £1million then there would be IHT to pay on the amount over that at a rate of 40 per cent.

If that is the case you can consider making gifts to reduce the size of the estate, but this requires careful planning so not to leave you short of assets for your own requirements. For example, if you live for seven years after making any sized gift to your children it will be tax-free under current rules.

Importantly, if you gift one of the homes your executors will not be able to claim the RNRB against it, so in this situation it would tend to make sense to gift the lower value of the two properties or some proceeds from a sale.

However, it sounds like it wouldn’t currently be necessary to do this, and it may be quite easy to keep below the £1million with some simple planning and structuring wills appropriately.

Zoe Brett, financial planner at EQ Investors, replies: Broadly, everyone gets the nil rate band of £325,000 however the residence nil rate band comes with some limitations, the key ones of which I have listed below.

• The property must pass to direct descendants

• You must have lived in the property at some point in your life

• It an only be applied to one property

• It is tapered where an estate is valued above £2million

Whether you can make full use of the residence nil rate band rather depends on the property valuations.

The residence nil rate band can only be used against one property. So, if the properties that you wish to leave to your children are individually valued at less than £350,000 then you will not be able to use the full benefits of the residence nil rate band.

Additionally, your executors may not have the freedom to select which property to use unless you have lived in both properties at some point in your life. The residence nil rate band is designed to pass the family home onto your children/grandchildren, it is not available for investment properties such as buy-to-lets.

Assuming you have lived in both properties at some point in your life, they would both qualify for residence nil rate band. This would give your executors the opportunity to select which property they wish to use the residence nil rate band against.

For example, if you had one property worth £150,000 and the other worth £250,000, the executors could choose to use the residence nil rate band against the £250,000 property as this would yield the greatest IHT saving. The other property along with any other assets would instead use the standard nil rate bands.

Provided the property that utilises the residence nil rate band is valued at £350,000 or more and that your entire estate is £1million or less, then you are correct, your entire estate would pass to your children free from of IHT.

Another big consideration around IHT mitigation is the future value of the estate. The nil mrate band has not increased for well over a decade (since 2009) and there is no indication that it will increase any time soon.

This means as your asset values grow, the potential IHT liability also grows as the nil rate band is not keeping pace with your asset value growth. Over this same period (2009-2026) the average property price in the UK has grown approximately 68 per cent, so keeping the value of your estate under £1million over a lifetime can be tricky.

However, all is not lost. There are other ways to reduce your estate ahead of time through gifting. In brief, you could gift the following to reduce your estate assuming affordability allows:

• £3,000 per year IHT exempt gift. This can be carried back one tax year if you did not use the previous tax years exemption.

• £250 smaller gifts allowance. These must be paid to different people than the person you utilise your £3,000 allowance with.

• Gifts out of regular income. If you have surplus income each month after paying your own living expenses, you can gift this IHT free.

• Larger lump sum gifts can be made but will not be completely outside of your estate unless you survive seven years.

There are other, far more complicated and risky methods to mitigate IHT though these would require formal financial advice.