Parents and grandparents will be able to leave homes worth up to £850,000 to their children and grandchildren without them paying inheritance tax from tomorrow, with the tax-free allowance rising to £1 million by 2020.

The move, which was announced by former Chancellor of the Exchequer George Osborne in 2015's Summer Budget, means that eventually each parent will be able to leave £500,000 in property – up from the current £325,000 per person limit – without paying inheritance tax. This will be phased in gradually between 6 April 2017 and 2020.

As allowances can be passed from one deceased partner to the other, when the first dies, their £500,000 allowance transfers to the other, giving the survivor a £1 million allowance.

For more help on how inheritance tax works and how to save £1,000s in other scenarios, see our Inheritance Tax guide.

Existing rule means 40% tax is paid on individual estates worth over £325,000

Under the old system, no inheritance tax is charged is on the first £325,000 (per person) of someone's estate – which is the value of their total assets they leave behind when they die. This is called the nil-rate band.

Couples could leave a home worth £650,000 without it attracting inheritance tax (singles £325,000).This remains unchanged. Above the threshold, the charge is 40% of the value of the property.

But from tomorrow the tax-free allowance will begin to increase:

  • A new tax-free 'main residence' band will be introduced, but it is only valid on a main residence and where the recipient of a home is a direct descendant (classed as children, step-children and grandchildren).

    It is being phased in gradually, starting at £100,000 - meaning a total allowance of £425,000 from 6 April 2017, rising by £25,000 each year until it reaches £175,000 - meaning a total allowance of £500,000 in 2020.

  • So as of 6 April 2017, the maximum that can be passed on tax-free is £850,000 for married couples or those in a civil partnership, £425,000 for others. For singles, this is made up of the existing £325,000, plus the extra £100,000. For couples, when the first one dies their allowance is passed to the survivor, so that £425,000 is doubled to £850,000.

The new inheritance tax allowance will be rolled out from tomorrow

Here's how it will work by April 2020:

  • The tax-free amount will rise to £1 million for couples (made up of £325,000 x two plus £175,000 x two) and £500,000 for singles (made up of £325,000 plus £175,000), as the main residence allowance rises.
  • On properties worth between £1 million and £2 million, inheritance tax will be paid as normal (40%) on the amount above the tax-free amount.
  • On properties worth £2 million or more, homeowners will lose £1 of the 'main residence' allowance for every £2 of value above £2 million. So for a couple, properties worth £2,350,000 or more will get no additional allowance.

Inheritance tax changes to be rolled out from tomorrow - what it means for you
By 2020 each parent will be able to leave £500,000 in property without paying inheritance tax

Tax break not as beneficial on properties owned by single parents

Children or grandchildren where a single parent owns the property won't receive the full effect of these inheritance tax benefits as those who are married or in a civil partnership.

Here, only properties worth up to £500,000 (by April 2020, £425,000 from April 2017) can be passed on completely tax-free as there is only one allowance in play, not the two that couples have.

New rule won't affect those who have downsized their property

Those who downsize now and therefore may have cash once their home is sold, where that money once formed part of the equity in a property, will still be able to pass on the same value of their estate tax-free to their dependents as had they kept a pricier property.

Various assets are subject to inheritance tax

When you die, the Government assesses how much your estate is worth, then deducts your debts from this to give the value of your estate. Your assets include:

  • Cash in the bank
  • Investments
  • Any property or business you own
  • Vehicles
  • Payouts from life insurance policies