As the inheritance tax (IHT) landscape becomes ever more complex, it is becoming increasingly clear that you don’t need to be rich to be caught out by tax.
Middle-class families with modest property holdings and pension savings are increasingly finding themselves in HMRC's crosshairs.
It was recently revealed that more than 4,000 bereaved families across the UK were approached by HMRC last year over underpaid IHT, compared with 3,000 the previous year. And against a backdrop of soaring home values, and plans for unspent pension savings to be counted towards a person’s estate for IHT purposes, many more families will be brought into scope.
The new reality
The current IHT framework provides individuals with two key allowances:
• A basic nil-rate band of £325,000
• An additional residence nil-rate band of £175,000 for estates up to the value of £2m. After this, it reduces by £1 for every additional £2 above the £2m taper threshold and is lost completely at £2.35m.
For married couples, these allowances can potentially combine to create a £1,000,000 threshold before inheritance tax becomes payable – but only when the family home is left to direct descendants.
The inclusion of pension pots in estate valuations will be a game-changer. Previously, many estates comfortably fell below the £1,000,000 threshold. Now, with substantial pension funds added to property values, bank accounts, and other assets, many more estates will cross into the 40% inheritance tax bracket.
The valuation minefield
When an estate is liable for inheritance tax, executors must complete an inheritance tax return that includes accurate valuations for every asset. While bank balances and shareholdings are straightforward to value, property presents a significant challenge.
The danger lies in getting property valuations wrong. If executors fail to obtain professional valuations and simply estimate property values, they leave themselves exposed to HMRC scrutiny. Even with professional valuations, problems can arise when properties subsequently sell for significantly more than their stated death-date value. According to recent figures published by Halifax, UK house prices hit a record high in August.
When HMRC comes calling
HMRC's District Valuer has the power to investigate property valuations, particularly when there's a substantial difference between the previously reported value and the eventual sale price. If the latter can be attributed to market movement or a "special purchaser" willing to pay above market rate, the difference may be treated as capital gains, which is taxed at 24% for higher rate taxpayers. If, on the other hand, HMRC believes the original valuation was simply wrong, they can demand inheritance tax at 40% on the difference.
So, the stakes are high. Consider a property initially valued at £500,000 that sells for £800,000. If HMRC's District Valuer determines the property was actually worth £650,000 at the date of death, the family faces additional inheritance tax of £60,000 (40% of the £150,000 difference), plus capital gains tax on the remaining £150,000 increase.
The role of professional valuations
Obtaining a professional property valuation immediately after death is key to preventing disputes. Executors who fail to engage qualified Chartered Surveyors leave themselves vulnerable to HMRC challenges and may struggle to defend their position.
However, even with professional valuations, executors need to be cautious. It is not unusual for us to challenge a valuation carried out on behalf of a client if we think it is too high. Equally, there can be problems if a valuation is considered too low. In some cases, surveyors provide a range of possible values, and it’s natural to opt for the lower end to minimise inheritance tax. But this relies on the surveyor staunchly defending their position if challenged by HMRC.
The complexity is compounded by the inevitable delays in the confirmation process. For estates paying inheritance tax, properties are often not sold for a year or more. During this extended period, property markets can shift significantly, creating natural disparities between death-date valuations and eventual sale prices.
Planning ahead
As the government seeks to plug budget gaps through increased inheritance tax collection, families must be more vigilant than ever about estate planning and property valuations. The best way to avoid unexpected tax bills is to seek professional advice immediately after death, not months later when problems materialise.
The inclusion of pension pots and the restriction of reliefs mean inheritance tax is no longer just a concern for the very wealthy.
If you're dealing with inheritance tax matters or need advice on estate planning, contact our specialist team for guidance tailored to your circumstances or visit our hub.
