Inheritance tax

The main residence allowance is an allowance of 'up to' £175,000 and not a flat rate.

So if your home is worth less than this and it passes straight to a direct descendant, such as a child or grandchild, then your main residence allowance would be equivalent to the property's value at the time of your death. So if your home is worth £150,000 then your main residence allowance would be £150,000 (you wouldn't have an extra £25,000 of allowance to offset against other taxes).

It gets slightly more complicated if, after you die, your home passes to your spouse and then, after their death, your home is inherited by your direct descendants.

In this situation, your spouse would have their own main residence allowance of up to £175,000, but also inherit your unused main residence allowance of up to £175,000 – so a combined allowance of up to £350,000. Note that your spouse would still inherit up to £175,000 of unused allowance even if your home was worth less than £175,000 at the point of your death (so using the example above, the amount of allowance your spouse inherits wouldn't be capped at £150,000).

When your spouse dies, and if the home passes to your direct descendants, then your spouse's main residence allowance would be equivalent to the lower of £350,000 (their allowance plus that which they inherited from you) and the value of the property at the point of their death.

So using the example above, if the property's value had increased to £250,000 by the time of your spouse's death, their main residence allowance would be £250,000. In the the situation where the property value had increased to £380,000 – say they die many years after you – your spouse's main residence allowance would be £350,000.

While transfers of property and other assets between married couples or civil partners don’t usually attract inheritance tax, this isn't the case for unmarried couples. 

If you're not married to your partner, but own assets together such as property, whether or not inheritance tax will be due on the property after one of you dies will depend on different factors. These include the basis on which you owned the property together, whether the deceased had a will and if their total assets exceeded the inheritance tax threshold:

• If you're joint tenants (you both own all the property), and your partner's left you everything in the will, then if your partner's assets – including the property – exceed the inheritance tax threshold, then tax will be payable on any assets in the estate above that. After your partner's death, the property would then be owned by you in its entirety. Even if your partner didn't leave a will, thanks to something called the 'right of survivorship', the property would still go entirely to you although the inheritance tax rules above would still apply. However, your partner's family would still have a claim to his or her share of other assets, such as insurance policies and pension investments.

• If you're tenants in common (you each own a specific percentage of the property), it's more complex. If your partner's made a will leaving their share to you, any inheritance tax would be paid out of the estate before the bequests are shared out. Inheritance tax may end up having to be paid on the property, but this would depend on the value of their total estate.

  If your partner's not made a will leaving their share to you, and you're tenants in common, their share will go to their relations. As an unmarried partner, you'd only be entitled to the share of the property you currently own.

It's especially important that if you own a property with someone who isn't your husband/wife or child, you make a will describing exactly who benefits on your death.

These rules are backdated – so will apply even if your partner died years ago. The key to how much extra allowance you get relies on the percentage (not the amount) of the allowance that your spouse used.

For example, if your partner died in 2012 and used 50% of their nil-rate allowance at the time of their death, you will get an extra 50% of the current allowance (in other words, 50% of £325,000).

In addition, you also get 100% of their main residence allowance, so another £175,000, which your partner wouldn't have used because it wasn't available in 2012. One hundred per cent of the main residence allowance will be available for transfer unless the estate was worth more than £2 million, in which case the main residence allowance starts to be reduced. 

This extra allowance (your partner's nil-rate allowance and main residence allowance) is on top of your own £500,000 total allowance. 

An example should help explain...

Let's say Mr Youngatheart passed away some years before Mrs Youngatheart, back when the nil-rate allowance was only £250,000. He gave £50,000 to each of his three children, meaning £150,000 was used – 60% of his allowance. All the rest went to Mrs Y.

When she dies, of course she can currently pass on £500,000 free of tax due to her own allowance (£325,000 + £175,000). But she can also pass on the unused amount of Mr Y's allowance free of tax. He didn't use 40% of his, so she gets another 40% of the current nil-rate amount, in other words, £130,000, plus 100% of Mr Y's main residence allowance, so another £175,000. This means her total tax-free allowance is currently £500,000 + £305,000, giving £805,000. 

Do note if you're not married or in a civil partnership then any unused inheritance tax allowance or residence nil rate band allowance can't be passed between you and your partner (this perk is strictly for married or civil-partnered couples).

This means if you're co-habiting with your partner and you've got kids together, it can be more complicated to reduce any potential inheritance tax liability. In situations such as these – particularly if you've got a large estate, including property – it can be worth seeking financial advice.

People in certain 'risky' roles are exempt from paying inheritance tax if they die in active service. Included in this are armed forces personnel, police, firefighters and paramedics, plus humanitarian aid workers.

The exemption also comes into play if a person who was injured on active service later dies as a result of the original injury, even if they're no longer on active service.

This is a sensible step for anyone thinking about the perils of inheritance tax, and what happens to your money once you're gone.

You should always try to do most things yourself as it's much cheaper. But if you have sizeable assets, then inheritance tax is one of the few occasions where paying for good professional legal or tax advice is well worth it – spend £100s to save £100,000s.

But first of all, consider if you're even caught by inheritance tax at all. If you and your spouse's total assets are under £650,000 (so property value, savings, inheritance and what'd be left from your pension), you shouldn't pay the tax anyway, so there's little point.

However, for those with bigger estates, an independent financial adviser may, depending on their qualification, be able to help (see our Financial advice guide), but a solicitor or tax accountant is a better bet for more specialised info. Preferably find one who is a member of the Society of Trust and Estate Practitioners (STEP) – take a look on the STEP and Chartered Institute of Taxation websites.

You can also get free 30- to 60-minute inheritance-planning advice via both VouchedFor* and Unbiased*, sites allowing you to search for local independent financial advisers. Follow our links, enter your postcode, and contact your chosen adviser by phone or online to arrange your free session, which you can use to ask questions and identify what steps you should take with your inheritance planning.

To make sure you get the most out of the session, it's a good idea to have a summary of your financial situation to hand – any savings, debt, incomings, outgoings – as well as details of existing wills, trusts and future plans.

Setting up a trust is a way of managing your assets (such as money, property, investments) on behalf of a beneficiary or loved one. You put some, or all, of your assets into a trust and a trustee then manages the trust, as per your instructions, on behalf of the beneficiaries.

Along with allowing you to exercise some control over how your assets are used or spent after you die, trusts can also be a way of passing on your assets more tax efficiently (one of the other reasons for setting up a trust).

Yet there are different types of trusts available and depending on the type different rules might apply, including in relation to inheritance tax. With some trusts you have to pay inheritance tax on setting up the trust, others when the trust has been in existence for 10 years, and others where you've made transfers into the asset during the seven years before your death.

As the rules around trusts and inheritance tax are complicated, if a trust is relevant to you it's best to seek financial advice. You can also find useful information about trusts and inheritance tax on Gov.uk.