Inheritance Tax in the UK is calculated by valuing the deceased’s estate, subtracting debts and exempt transfers, applying any reliefs, and charging 40% on whatever exceeds the available tax-free thresholds. Most individuals get a £325,000 nil-rate band, rising to £500,000 where a family home passes to children or grandchildren, and married couples or civil partners who plan carefully can pass on up to £1 million tax-free.1GOV.UK. How Inheritance Tax Works: Thresholds, Rules and Allowances The calculation itself follows a fixed order: value, deduct, exempt, relieve, then measure the remainder against the thresholds.
Step One: Value the Estate
Everything the deceased owned at death goes into the gross estate. That means property, savings, investments, vehicles, jewellery, and their share of anything held jointly. Each asset is valued at its open market price on the date of death. Property and unlisted shares usually need a professional valuation.
From the gross figure, subtract allowable debts: outstanding mortgage balances, credit card debt, utility bills, and reasonable funeral costs. The result is the net estate, and this is the number the rest of the calculation works with.
What Falls Outside the Estate
Pension pots generally sit outside the estate for IHT. Most scheme death benefits are paid at the pension provider’s discretion, which keeps them out of the calculation.2GOV.UK. Tax on a Private Pension You Inherit If the provider has no discretion over who receives the payout, the lump sum may count as part of the estate, so check the scheme rules. From 6 April 2027, most unused pension funds and death benefits will be brought within IHT.3GOV.UK. Inheritance Tax – Unused Pension Funds and Death Benefits For deaths before that date, the current exemption still applies.
Life insurance depends on how the policy is held. Written into trust, the payout goes to the trust beneficiaries and stays outside the estate. Without a trust, it forms part of the estate and is taxable like any other asset.
Step Two: Apply the Exemptions
Exemptions are subtracted before you measure the estate against the nil-rate bands, and they often reduce the taxable amount dramatically.
Spouse and Civil Partner Transfers
Assets passing between married couples or civil partners are fully exempt from IHT, whether transferred during life or on death. This is the reason many estates pay no tax at all on the first death.1GOV.UK. How Inheritance Tax Works: Thresholds, Rules and Allowances If the receiving spouse is not a long-term UK resident for IHT purposes, the exemption is capped at £325,000.4HM Revenue & Customs. Inheritance Tax Manual – IHTM11033 – Spouse or Civil Partner Exemption: Spouse or Civil Partner Domiciled Outside UK From 6 April 2025, the old domicile test was replaced by a long-term UK residence test.5GOV.UK. Inheritance Tax if Youre a Long-Term UK Resident
Charity Gifts and the 36% Reduced Rate
Gifts to qualifying UK charities, political parties, and certain national institutions are entirely exempt, whether given during life or left in a will. There is also a rate incentive: if at least 10% of the net estate (after the nil-rate bands and reliefs) goes to charity, the IHT rate on the remaining taxable estate drops from 40% to 36%. On a large estate, that reduction can save more in tax than the charitable gift itself costs, so it is worth modelling carefully.
Step Three: Apply the Reliefs
Two reliefs matter for people with business or farming assets. Most estates won’t touch these, but the boundary is worth knowing.
Business Property Relief (BPR) reduces the taxable value of qualifying business assets. Full 100% relief applies to a business or interest in a business, and to shares in an unlisted company. 50% relief applies to shares controlling more than 50% of voting rights in a listed company, and to land, buildings, or machinery owned by the deceased but used in a business they controlled.6GOV.UK. Business Relief for Inheritance Tax: What Qualifies for Business Relief The deceased must have owned the asset for at least two years, and the business must be a genuine trading operation. Investment businesses, including most property-letting companies, do not qualify.
Agricultural Property Relief (APR) works similarly for farmland. 100% relief covers land farmed by the owner, land used by someone else under a short-term grazing licence, and land let on a tenancy beginning on or after 1 September 1995. 50% relief covers most other qualifying agricultural land.7GOV.UK. Agricultural Relief for Inheritance Tax APR applies only to the agricultural value of the land, not to any development or hope value.
From 6 April 2026, 100% BPR and APR are only available on the first £2.5 million of combined qualifying assets per estate. Qualifying assets above that threshold receive 50% relief.8GOV.UK. Inheritance Tax Reliefs Threshold to Rise to 2.5m for Farmers and Businesses The £2.5 million allowance is transferable between spouses. As part of the same reform, shares traded on exchanges that are not recognised stock exchanges (most notably AIM-listed shares) now qualify for only 50% BPR regardless of value. Before April 2026, these shares attracted 100% relief as “unlisted” shares.
Step Four: Apply the Nil-Rate Bands
Once exemptions and reliefs are off the table, the remaining net estate is measured against two tax-free thresholds. Both are frozen at their current levels until at least April 2030.9GOV.UK. Inheritance Tax Thresholds and Interest Rates
The Standard Nil-Rate Band
The standard nil-rate band (NRB) is £325,000. The first £325,000 of the net estate passes tax-free; everything above is taxed at 40%.1GOV.UK. How Inheritance Tax Works: Thresholds, Rules and Allowances
When the first spouse or civil partner dies without using their full NRB, the unused percentage transfers to the survivor. If the first spouse left everything to the surviving partner (fully exempt), none of their NRB was used, and the survivor’s estate gets a double allowance of £650,000.10GOV.UK. Inheritance Tax Nil-Rate Band and Residence Nil-Rate Band From 6 April 2028 The transfer is automatic in principle, but the executor must claim it on the IHT return.
The Residence Nil-Rate Band
The residence nil-rate band (RNRB) adds another £175,000, but only when the estate includes a home the deceased lived in and that home passes to direct descendants such as children, grandchildren, or stepchildren.11GOV.UK. Work Out and Apply the Residence Nil Rate Band for Inheritance Tax The allowance is capped at the lower of £175,000 or the net value of the home itself, so a home worth £120,000 only generates £120,000 of RNRB.
Any unused RNRB from the first spouse also transfers to the survivor. A couple can combine both bands for a total tax-free threshold of up to £1 million (£650,000 NRB plus £350,000 RNRB).
The £2 Million Taper
Larger estates lose the RNRB through a taper. For every £2 the net estate exceeds £2 million, the RNRB shrinks by £1.11GOV.UK. Work Out and Apply the Residence Nil Rate Band for Inheritance Tax An estate worth £2.35 million loses the entire £175,000 RNRB.
There is a catch. The estate value used for this taper calculation does not account for exemptions or reliefs. You total all assets, subtract debts, and compare that figure to the £2 million threshold before applying the spouse exemption or business property relief. An estate worth £2.4 million where half passes to a surviving spouse still loses its RNRB, even though the taxable portion after the spouse exemption may be well under £2 million.
Step Five: Add Back Gifts Made in the Last Seven Years
IHT captures gifts made in the years leading up to death. Without this rule, anyone could give everything away on their deathbed and pay nothing.
Potentially Exempt Transfers
A gift from one individual to another is a Potentially Exempt Transfer (PET). If the donor survives for seven years after making the gift, it drops out of the IHT calculation entirely. If the donor dies within those seven years, the full value of the gift is added back into the estate and may use up some or all of the deceased’s nil-rate band.12GOV.UK. How Inheritance Tax Works: Rules on Giving Gifts
Gifts get added back in chronological order, oldest first, and they use up nil-rate band before the death estate does. That order matters. A large gift made six years before death can absorb the entire NRB, leaving the rest of the estate exposed to 40% on almost everything.
Taper Relief on Failed Gifts
When a PET becomes chargeable because the donor died within seven years, taper relief reduces the IHT rate on the gift itself, depending on how long the donor survived:12GOV.UK. How Inheritance Tax Works: Rules on Giving Gifts
- 0 to 3 years before death: no reduction, full 40% rate.
- 3 to 4 years: effective rate 32%.
- 4 to 5 years: effective rate 24%.
- 5 to 6 years: effective rate 16%.
- 6 to 7 years: effective rate 8%.
Taper relief only reduces the tax charged on the gift itself. It does not reduce the amount of nil-rate band the gift uses up, which is a common misconception. A £400,000 gift made five years before death still absorbs the full £325,000 NRB, leaving nothing for the rest of the estate.
Gifts With Reservation of Benefit
A gift does not count as a transfer if the donor continues to benefit from the asset. Giving your house to your children but continuing to live there rent-free is the classic example.12GOV.UK. How Inheritance Tax Works: Rules on Giving Gifts The asset remains part of the estate for IHT purposes as though the gift never happened.
Gifts That Never Enter the Calculation
Some gifts are free of IHT immediately, regardless of the seven-year rule:
- Annual exemption: each person can give away up to £3,000 per tax year. If unused, the exemption carries forward for one year only, giving a maximum of £6,000 in a single year.12GOV.UK. How Inheritance Tax Works: Rules on Giving Gifts
- Small gifts: unlimited gifts of up to £250 per recipient per tax year, provided you have not used any other exemption for the same person.
- Wedding or civil partnership gifts: up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, or £1,000 to anyone else.
- Normal expenditure out of income: regular gifts funded from income (not savings) that leave the donor’s standard of living unaffected are fully exempt with no upper limit. Keeping detailed records of income and expenditure patterns is critical, because HMRC scrutinises these claims heavily.13HM Revenue & Customs. Inheritance Tax Manual – IHTM14231 – Lifetime Transfers: Normal Expenditure Out of Income: Introduction
A Worked Example
Suppose a widow dies in 2026 with a net estate of £900,000. Her estate includes a home worth £400,000 left to her two children, and her late husband used none of his nil-rate band or RNRB when he died.
Her executor claims the transferred allowances. The combined nil-rate bands are £650,000 (NRB) plus £350,000 (RNRB), a total of £1 million. Since the estate is worth £900,000, it falls entirely within the combined threshold and no IHT is due.
Now change the facts. Say the estate is worth £1.3 million. The first £1 million is covered by the combined nil-rate bands. The remaining £300,000 is taxed at 40%, producing a bill of £120,000. If she had left at least 10% of her net estate (after the nil-rate bands) to charity, the rate on that £300,000 would drop to 36%.
When the Tax Has to Be Paid
IHT must be paid by the end of the sixth month after the month of death to avoid interest. Someone who dies in March 2026 triggers a payment deadline of 30 September 2026.14GOV.UK. How to Value an Estate for Inheritance Tax and Report Its Value Interest on unpaid IHT currently runs at 7.75%.9GOV.UK. Inheritance Tax Thresholds and Interest Rates
For certain hard-to-sell assets, HMRC allows the tax to be spread over ten equal annual instalments. Qualifying assets include houses, businesses run for profit, controlling shareholdings, and certain unlisted shares meeting minimum value thresholds.15GOV.UK. Pay Your Inheritance Tax Bill: In Yearly Instalments Interest accrues on the outstanding balance throughout the instalment period.