How to Calculate Inheritance Tax on Gifts and Reduce Your Liability Efficiently

Planning to gift your belongings while you’re still around? That’s a generous move—but before you start handing out cheques or transferring property, there’s something important you need to understand: Inheritance Tax (IHT).

In the UK, gifts can be a smart way to help loved ones and reduce the value of your estate. But there’s a catch: some gifts could still be subject to tax if you pass away within a certain number of years after making them.

Sound confusing? Don’t worry. In this blog post, we’ll break it down so it’s easy to understand. We’ll walk you through how inheritance tax on gifts works, show you how to calculate what’s owed, and share smart ways to minimize your IHT liability.

What Is Inheritance Tax (IHT)?

Inheritance Tax is a tax on the value of your estate—everything you own at the time of death, like your home, savings, or valuable belongings.

But it’s not just what you leave behind in your will. Some gifts you give while you’re alive can also be taxed when you die.

The Nil Rate Band: Everyone Gets a Tax-Free Allowance

Before diving into gifts, understand this key concept: most people have a tax-free allowance called the “Nil Rate Band” (currently £325,000 as of 2023/24). This means the first £325,000 of your estate isn’t taxed at all.

Anything above that may be taxed at 40%.

How Gifts Are Treated for Inheritance Tax

Not all gifts are created equal when it comes to IHT. Let’s talk about how gifts work under inheritance tax rules.

What Counts As a “Gift”?

In tax terms, gifts are more than just birthday presents. HMRC considers something a gift if:

• Its value can be measured—like money, property, shares, or valuable items.
• You no longer benefit from it—meaning you don’t still live in the house you “gifted” or drive the car you “gave away.”

Seven-Year Rule: Timing Is Everything

One of the golden rules with inheritance tax on gifts is the “seven-year rule.”

If you gift something and survive for seven more years, that gift is completely exempt from inheritance tax.

But if you pass away within that period, the gift might be taxed, depending on:

• Who you gave it to
• When you gave it
• Whether any other gifts were made during that period

This tax applies specifically to Potentially Exempt Transfers (PETs). That’s the official name for gifts made to individuals or certain trusts.

Taper Relief: Paying Less If You Die After 3 Years

Here’s a little relief: If you die between 3 and 7 years after making the gift, HMRC reduces the tax owed using something called “taper relief.”

Here’s how it works:

After 7 years, the gift is tax-free!

How to Calculate Inheritance Tax on Gifts

Let’s walk through the calculation step-by-step.

Step 1: Add Up the Value of All Gifts

Start by listing all taxable gifts made in the last seven years, along with their value at the time they were given. If you paid any fees such as solicitors or stamp duty to make the gift, HMRC allows you to reduce the gifted value by those costs.

Step 2: Apply The Nil Rate Band

If the value of all gifts (in chronological order, starting with the oldest) is less than £325,000, there’s no inheritance tax. Once your gift values go above that threshold, tax kicks in on the excess.

Step 3: Apply The Right Tax Rate

Depending on how many years passed since each gift was made, apply the appropriate rate from the taper relief table above.

Example:

Let’s say you gave your son £200,000 five years before you died and you had already used up your nil rate band on earlier gifts.

IHT on £200,000 with a 16% taper relief rate = £32,000

Which Gifts Are Exempt from Inheritance Tax?

HMRC won’t tax everything you give away. Some gifts are always IHT-free, no matter when you give them:

• Annual exemption: You can gift up to £3,000 every tax year without paying IHT. If unused, this can carry forward one year.
• Small gifts: Give up to £250 per person per year tax-free (these don’t combine with the £3,000 exemption).
• Gifts to spouses or civil partners: Always exempt if they live in the UK.
• Gifts to charities: Completely tax-free and can reduce IHT rate on the rest of your estate (to 36%) if you leave at least 10% to charity in your will.
• Wedding gifts: Up to £5,000 for your child, £2,500 for a grandchild, or £1,000 for a friend getting married.
• Gifts from surplus income: As long as it doesn’t affect your standard of living, gifts made from regular excess income are tax-exempt.

Smart Ways to Reduce Inheritance Tax on Gifts

Now that you know how the tax works, you’re probably wondering how to avoid it. Fortunately, there are a few smart strategies:

1. Gifting Early

The sooner you make gifts, the better. Surviving more than 7 years after giving a gift means zero IHT.

2. Use Annual Exemptions

These allowances reset every tax year, so make use of them consistently. A couple making regular £3,000 gifts can pass on tens of thousands over a decade without any tax.

3. Spread Larger Gifts Over Time

If possible, break up large gifts into several smaller ones over a few tax years to stay within exemptions.

4. Make Gifts from Surplus Income

If your income (pensions, rents, etc.) exceeds your expenses, gifting from this surplus avoids inheritance tax—forever. But be sure to keep good records as HMRC may request proof.

5. Consider Using Trusts

For more complex estates or if you want to control how gifts are used (for example, for future grandchildren’s education), putting assets into a trust can help. But it can also come with its own tax rules, so always speak to a financial advisor or solicitor.

6. Update Your Will and Estate Plan Regularly

If your circumstances or UK tax laws change, your strategy might need to change too. Regular reviews ensure your gifts and estate are handled the way you want—and as tax-efficiently as possible.

FAQs About Inheritance Tax on Gifts

What happens if I give someone a house?

Gifting property counts just like money or shares. If you continue living in the home rent-free after giving it away, it’s called a “gift with reservation of benefit” and may still be seen as part of your estate for IHT purposes.

How are multiple gifts handled?

Remember, gifts are treated in the order they were made. If your first gift uses up the nil rate band, the next ones will be taxable and subject to taper relief, depending on the year they were given.

Final Thoughts

Gifting is a thoughtful way to share your wealth and reduce the future tax burden on your loved ones. But timing and strategy are everything. By understanding how inheritance tax applies to gifts, using tax-free allowances, and giving with purpose, you can pass on more of your hard-earned assets the smart way.

The system can be a little tricky, but with the right planning (and maybe some professional advice), you’ll make sure your generosity makes the biggest possible impact—without unnecessary tax bites.

Want to learn more or see the official government guidance?

👉 Click here for HMRC’s full guide on Inheritance Tax on Gifts.