Gifts & the 7-Year Rule

Potentially Exempt Transfers (PETs)

A Potentially Exempt Transfer (PET) is a gift to an individual (or to certain types of trust) that is not immediately chargeable to IHT. Most lifetime gifts to other people — cash, shares, property, personal possessions — are PETs. The gift becomes fully exempt once the donor survives for seven years after making it. If the donor dies within seven years, the PET becomes chargeable and is added to the estate. The gift is valued at the date of the transfer — any future growth in value is ignored for IHT purposes (this is a significant advantage). The recipient's basis for future capital gains tax is the original owner's cost, not the value at the date of transfer. PETs are reported on the IHT400 account if the donor dies within seven years. The value of all PETs made in the seven years before death is cumulated, and any amount above the available nil-rate band is taxed at 40%. PETs made more than seven years before death are not reportable and do not affect the estate at all. This makes lifetime giving one of the most effective IHT planning strategies — a healthy 70-year-old who gives away £500,000 to their children and survives another seven years has removed that entire sum from their estate.

Tapering Relief

If a PET becomes chargeable because the donor died within seven years, tapering relief (sometimes called "taper relief") may reduce the amount of IHT payable. Tapering relief applies to gifts made between three and seven years before death and reduces the tax rate, not the value of the gift. It only applies to the extent that the total value of chargeable gifts exceeds the nil-rate band. The tapering rates are: three to four years before death — 32% (80% of 40%), four to five years — 24% (60% of 40%), five to six years — 16% (40% of 40%), six to seven years — 8% (20% of 40%). Gifts made within three years of death are taxed at the full 40% rate with no tapering. Importantly, the nil-rate band is allocated to gifts in chronological order — the earliest gift within seven years uses the NRB first. This means if the cumulative value of gifts is less than the nil-rate band, no IHT is due regardless of when the gifts were made. Tapering relief only helps when gifts exceed the available nil-rate band. A common mistake is to assume that surviving four years means only 24% IHT is due on the full gift value; in fact, the nil-rate band is applied first, and only the excess is subject to tapering.

Annual Exemptions

Certain gifts are always exempt from IHT regardless of when you die. The most important is the £3,000 annual exemption. You can give away up to £3,000 in total each tax year without any IHT implications. If you do not use your annual exemption in one tax year, you can carry it forward to the next, but only for one year — unused exemptions cannot accumulate further. Married couples each have their own £3,000 annual exemption, so a couple can give away £6,000 per year combined. The normal expenditure from income exemption is extremely valuable for those with surplus income. Gifts made out of income (not capital) as part of a regular pattern are exempt from IHT if they do not reduce your standard of living. There is no upper limit — regular gifts to children, grandchildren, or other family members can remove significant value from your estate provided they are genuinely paid from income. You must keep records showing the payments are regular and come from income. The small gifts allowance allows you to give up to £250 per person per tax year to any number of individuals. These gifts do not count against your £3,000 annual exemption. Finally, wedding and civil partnership gifts are exempt up to £5,000 for a child, £2,500 for a grandchild, and £1,000 for anyone else.

Chargeable Lifetime Transfers (CLTs)

Gifts into most types of trust are Chargeable Lifetime Transfers (CLTs). Unlike PETs, CLTs may trigger an immediate IHT charge. If the value of the CLT (plus any other CLTs made in the previous seven years) exceeds the nil-rate band, IHT is due at 20% (half the death rate) on the excess. The nil-rate band for lifetime transfers is the same £325,000 used for death estates. If you have already used part of your NRB on earlier CLTs, the available balance is reduced. Trusts also face periodic IHT charges every ten years (the "10-yearly charge") and exit charges when capital leaves the trust. These charges are calculated based on the trust value and the history of transfers into the trust. Since 22 March 2006, most trusts created during lifetime are subject to the relevant property regime, which imposes these ongoing charges. Bare trusts and certain trusts for disabled persons are exceptions. CLTs are reported to HMRC on form IHT100 within 12 months of the transfer. If the sum transferred is below the nil-rate band and no other CLTs have been made, no reporting is required. However, you should still keep records as the trust will face periodic charges. Professional advice is essential before creating any trust, as the ongoing tax compliance costs can be significant.

Gifts with Reservation of Benefit

A critical anti-avoidance rule is the gifts with reservation of benefit (GROB) legislation. If you give away an asset but continue to benefit from it — for example, giving away your house but continuing to live in it rent-free — HMRC treats the asset as still forming part of your estate. This means the gift is ineffective for IHT purposes. The only way to avoid the GROB rules when giving away a home is to pay market rent to the new owners, which must be declared as their income. Alternatively, you can sell the property at market value and gift the proceeds, but this triggers capital gains tax on any gain. The pre-owned assets tax (POAT) rules introduce an additional income tax charge on individuals who continue to benefit from assets they formerly owned. If you are caught by POAT, you pay income tax on the value of the benefit rather than having the asset treated as part of your estate. You can elect to include the asset in your estate instead, which may be preferable. These rules make it difficult to give away your home or valuable assets while continuing to enjoy them. Proper estate planning should use different strategies — such as downsizing, equity release, or using a will trust — rather than attempting to gift assets while retaining use.

FAQs

Can I give my house to my children and still live in it?

If you give away your house but continue to live there without paying market rent, it is a gift with reservation of benefit and the house remains in your estate for IHT purposes. To make the gift effective, you must pay the new owners a full market rent, which they must declare as income. Alternative strategies include downsizing and gifting the surplus cash, or using a lifetime trust.

How does the seven-year rule work for gifts within a trust?

Gifts into a discretionary trust are immediately chargeable lifetime transfers (CLTs), not PETs. If the gift exceeds the nil-rate band, IHT at 20% is due immediately. The seven-year rule still applies for cumulation purposes, but the gift is chargeable from the outset rather than becoming chargeable on death.

Do I need to keep records of gifts I make?

Yes. You should keep a record of all gifts, their value, the date of transfer, and the recipient. Your executors will need this information to complete the IHT400 if you die within seven years. For regular gifts from income, keep bank statements and a schedule showing the pattern of payments.