How does the seven-year rule work for gifts and Inheritance Tax?

Full answer

The seven-year rule governs how lifetime gifts (beyond your various annual exemptions) are treated for Inheritance Tax purposes, and understanding it properly requires distinguishing between the gift becoming tax-free versus taper relief merely reducing the RATE of tax charged. **Gifts becoming entirely IHT-free after seven years** Most lifetime gifts to individuals (known as 'potentially exempt transfers', or PETs) become completely free of Inheritance Tax if the person making the gift survives for at least seven years after making it -- if they do survive seven years, the gift falls outside their estate entirely for IHT purposes, regardless of its value. **What happens if death occurs within seven years** If the person making the gift dies within seven years, the gift is added back into their estate for IHT calculation purposes (using its value AT THE TIME OF THE GIFT, not at death), assessed against their available nil rate band (£325,000, plus any residence nil rate band if applicable) in date order, with earlier gifts using up the nil rate band first before later gifts and the remaining estate. **Taper relief -- a common misunderstanding** Taper relief reduces the RATE of tax charged on a gift that becomes taxable because it exceeds the available nil rate band, on a sliding scale for gifts made between three and seven years before death (broadly reducing the standard 40% rate progressively the closer to seven years the gift was made) -- but taper relief does NOT reduce the VALUE of the gift counted against the nil rate band, and provides no benefit at all for gifts within three years of death, or for gifts that are already fully covered by the available nil rate band (since there is no tax to taper in the first place). **Worked example** Someone gives £400,000 to their child five and a half years before they die, having made no other significant gifts and having their full £325,000 nil rate band available. £325,000 of the gift is covered by the nil rate band and is tax-free; the remaining £75,000 is taxable. Because the gift was made between five and six years before death, taper relief reduces the tax rate applied to that £75,000 (the exact percentage reduction depends on which specific year band it falls into), resulting in a lower tax bill than if the same gift had been made, say, one year before death, though still higher than if it had been made more than seven years before death (when it would have been entirely tax-free). **Gifts using up the nil rate band before the estate does** A common misunderstanding is thinking taper relief helps small gifts avoid all tax -- in reality, if a gift is fully covered by the available nil rate band, there is no tax on it regardless of when within the seven years it was made, so taper relief is only relevant once a gift (combined with any earlier gifts in the same seven-year look-back) exceeds the available nil rate band. **Practical tip** Keep a clear written record of the date and value of every significant lifetime gift you make, since executors need this information to correctly calculate any IHT due on your estate, and consider that gifts made EARLIEST within the seven-year window use up the nil rate band first, meaning the ORDER gifts were made in can materially affect which specific gifts end up being taxed if death occurs within seven years.

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