Inheritance Tax & Gifting Rules: Nil Rate Band Explained

Inheritance Tax (IHT) in the United Kingdom is one of the most heavily scrutinized and financially impactful taxes on family wealth. Under the statutory framework of the Inheritance Tax Act 1984 (IHTA 1984), estates exceeding tax-free allowances face a steep 40% tax rate on all qualifying property, cash, investments, and personal assets upon death. With sustained long-term property inflation across London, the South East, and the wider UK, hundreds of thousands of middle-income families and property owners find their estates pushed well above the statutory nil rate bands.

Fortunately, UK tax law provides powerful, legitimate statutory exemptions, gifting reliefs, and allowances that can dramatically reduce or completely eliminate an estate’s future IHT liability. This comprehensive, HMRC-audited guide breaks down the 2026/27 Nil Rate Bands, the £175,000 Residence Nil Rate Band (RNRB), the 7-year gifting taper relief rule, the Section 21 Normal Expenditure Out of Income exemption, trust planning, and the dangerous “Gift with Reservation of Benefit” trap.

To calculate your estate’s potential liability, model spousal band transfers, and calculate gifting timelines, use our HMRC-aligned Inheritance Tax Calculator.

Executive Summary: Master Inheritance Tax Allowances (2026/27)

Chapter 1: The Nil Rate Bands – How the £1 Million Spousal Threshold Works

Under UK tax legislation, every individual is entitled to a baseline tax-free allowance known as the Nil Rate Band (NRB), fixed at £325,000 under Section 7 of the Inheritance Tax Act 1984. Any assets left up to £325,000 are taxed at a rate of 0%.

1. Inter-Spousal Exemption & Transferable NRB (TNRB)

Under IHTA 1984 s.18, transfers of assets between legally married spouses or registered civil partners (who are both UK-domiciled) are 100% exempt from Inheritance Tax, regardless of the value. When the first spouse dies and leaves their entire estate to the surviving partner:

• Zero IHT is paid on the first death.
• 100% of the first spouse’s £325,000 NRB remains unused.
• Under IHTA 1984 s.8A, the surviving spouse’s estate can claim the unused percentage of the first spouse’s NRB upon the second death.
• This creates a combined baseline NRB of £650,000 for the surviving spouse’s estate.

2. The Residence Nil Rate Band (RNRB – £175,000)

Introduced under Finance (No. 2) Act 2015 and codified under IHTA 1984 s.8D, the Residence Nil Rate Band provides an additional allowance of up to £175,000 per person when passing a qualifying residential property to “direct descendants”.

• Qualifying Direct Descendants: Children, grandchildren, great-grandchildren, stepchildren, adopted children, foster children, and their respective spouses/civil partners. (Note: Siblings, nieces, nephews, and cousins do not qualify).
• Qualifying Property: The deceased must have lived in the residential property at some point as their main residence. Buy-to-let properties that were never inhabited by the deceased do not qualify.
• Transferable to Spouse: Like the NRB, 100% of any unused RNRB is transferable to the surviving spouse, creating a combined RNRB of £350,000.
• The £1,000,000 Milestone: Combining £650,000 (NRBs) + £350,000 (RNRBs) allows a married couple to pass an estate worth up to £1,000,000 completely free of Inheritance Tax to their children.

3. The £2 Million RNRB Taper Trap

Under IHTA 1984 s.8G, if the net value of an estate (before deducting exemptions and reliefs, but after deducting liabilities like mortgages) exceeds £2,000,000, the RNRB is reduced by £1 for every £2 of value above £2,000,000:

Downsizing Addition (IHTA 1984 s.8FA): If you sold your family home or downsized to a smaller property after 8 July 2015 (for example, moving into sheltered accommodation or a bungalow), your estate can still claim the full RNRB as a “Downsizing Addition”, provided the downsized property and equivalent equity are passed to direct descendants.

Chapter 2: Immediately Exempt Gifts – Give Away Wealth Tax-Free

Under UK law, certain gifts made during your lifetime are completely exempt from Inheritance Tax from the very second they are given. They are never added back to your estate, regardless of how long you survive after gifting:

1. The £3,000 Annual Exemption (IHTA 1984 s.19)

Every individual can gift up to £3,000 each tax year (6 April to 5 April) free of IHT to any recipient(s). If you do not use your full £3,000 annual exemption in one tax year, the unused portion can be carried forward for exactly one tax year (allowing a married couple to gift up to £12,000 tax-free in a single year if neither used their allowance in the prior year).

2. The £250 Small Gifts Exemption (IHTA 1984 s.20)

You can make unlimited gifts of up to £250 per person per tax year to as many different individuals as you wish (such as grandchildren, friends, or nieces/nephews). Condition: You cannot give a £250 small gift to someone who has already received any part of your £3,000 annual exemption in that tax year.

3. Wedding & Civil Partnership Gifts (IHTA 1984 s.22)

Gifts made on or shortly before the occasion of a wedding or civil partnership ceremony are immediately exempt up to specific limits:

• £5,000 to a child (from each parent).
• £2,500 to a grandchild or great-grandchild.
• £1,000 to any other relative or friend.

4. Normal Expenditure Out of Income (IHTA 1984 s.21) – The Unlimited Exemption

Section 21 of the Inheritance Tax Act 1984 is arguably the most powerful yet underutilized estate planning relief in the UK tax system. It allows an individual to give away unlimited sums of money tax-free, provided three statutory conditions are satisfied:

1. The gift was made as part of the donor’s normal expenditure: There must be an established regular pattern of giving, or a clear intention to give regularly (e.g., monthly bank standing orders).
2. The gift was made out of genuine net income: The money must originate from current income (salary, pensions, rental profits, dividends, interest), NOT from capital, savings, or asset sales.
3. The donor maintains their normal standard of living: After making the gifts, the donor must have sufficient remaining net income to maintain their usual lifestyle without drawing down on capital reserves.

“There is no upper limit on Section 21 gifts. A retiree with £60,000 in surplus annual pension and rental income can gift £50,000 every year to their children. Over 10 years, that is £500,000 removed from their estate, saving £200,000 in Inheritance Tax with zero 7-year waiting period.”

David Vance, CTA FCA

Chapter 3: Potentially Exempt Transfers (PETs) & The 7-Year Taper Rule

Any lifetime gift of capital or assets (such as cash, property, or shares) made to another individual that exceeds your annual exemptions is classified as a Potentially Exempt Transfer (PET) under IHTA 1984 s.3A.

A PET is not immediately taxed. If you survive for at least 7 full years from the exact date of the gift, the transfer becomes completely exempt and falls outside your estate for IHT purposes. However, if you die within 7 years, the PET fails and is pulled back into the IHT calculation.

The Statutory Taper Relief Schedule (IHTA 1984 s.7(4))

If death occurs between 3 and 7 years after making the gift, Taper Relief reduces the amount of tax payable on the gift itself (provided the total lifetime gifts exceed the £325,000 Nil Rate Band):

The “First in Time” Nil Rate Band Rule: A common misconception is that taper relief applies to all gifts under 7 years. In statutory ordering, lifetime gifts consume your £325,000 Nil Rate Band first in chronological order. If you gift £200,000 and die 4 years later, that £200,000 gift uses £200,000 of your NRB. Because it is within the £325,000 allowance, the tax on the gift is £0, meaning no taper relief applies to the gift, but your remaining death estate only has £125,000 of NRB left.

Chapter 4: Anti-Avoidance – The “Gift with Reservation of Benefit” (GWR) Trap

One of the most dangerous traps for property owners is attempting to gift the family home to adult children while continuing to reside in the property. Under Section 102 of the Finance Act 1986, this is classified as a Gift with Reservation of Benefit (GWR).

• The Statutory Consequence: If you give away an asset but retain any possession, enjoyment, or benefit from it rent-free, HMRC treats the property as remaining 100% inside your death estate for IHT purposes, regardless of how many decades have elapsed since the deed was signed.
• Capital Gains Tax Double Whammy: When you gift the house, the children acquire it at current market value. If they do not live in the house as their primary residence, any future capital appreciation triggers Capital Gains Tax (18%/24%) when eventually sold, while your estate still owes 40% IHT on death!
• The Legitimate Exemption – Full Commercial Market Rent: To prevent a gift of property from being treated as a GWR, the donor must pay full open market rent (formally assessed by an independent RICS surveyor) to the children, reviewed and adjusted annually, and pay their proportionate share of utility and council tax bills. (Note: The rent received by the children constitutes taxable rental income on their Self-Assessment).

Chapter 5: Trusts & Chargeable Lifetime Transfers (CLTs)

Trusts offer asset protection, control over when beneficiaries receive capital, and long-term estate structuring:

Chapter 6: Business Relief (BR) & Agricultural Property Relief (APR)

Under IHTA 1984 s.104, Business Relief (formerly Business Property Relief or BPR) provides up to 100% relief from Inheritance Tax for qualifying business assets held for at least two years prior to death:

• 100% Business Relief: Qualifying unquoted trading company shares (including AIM-listed shares), sole trader businesses, or partnerships actively trading.
• Property Exclusion Rule (IHTA 1984 s.105(3)): Businesses that consist wholly or mainly of holding or making investments, dealing in land or property, or holding shares (e.g., standard buy-to-let property portfolios and property investment companies) are explicitly excluded from Business Relief.
• Agricultural Property Relief (APR): Provides 100% relief on the agricultural value of UK farmland, pastures, and farmhouses occupied for agricultural purposes for at least two years by the owner or seven years by a tenant.

Chapter 7: 4 Worked Mathematical Scenarios (2026/27 Tax Year)

Scenario 1: Married Couple with £1,400,000 Estate Passing to Children

Arthur and Beatrice own a family home worth £750,000 and £650,000 in savings, ISAs, and investments (Total estate: £1,400,000). Arthur passes away first, leaving his entire estate to Beatrice. Beatrice subsequently dies, leaving the combined estate to their two adult children.

• Step 1: First Death (Arthur): Spousal exemption applies (*IHTA 1984 s.18*). IHT = £0. 100% of Arthur’s £325k NRB and £175k RNRB transfer to Beatrice.
• Step 2: Second Death (Beatrice): Gross Estate = £1,400,000.
• Step 3: Apply Combined Nil Rate Bands:
  • Combined NRB: £325,000 + £325,000 = £650,000.
  • Combined RNRB: £175,000 + £175,000 = £350,000 (Home value £750k exceeds £350k).
  • Total Tax-Free Allowance: £650,000 + £350,000 = £1,000,000.
• Step 4: Calculate Net Chargeable Estate: £1,400,000 − £1,000,000 = £400,000.
• Step 5: Calculate Tax Liability: 40% × £400,000 = £160,000.
• Net Inheritance Passed to Children: £1,400,000 − £160,000 = £1,240,000.

Scenario 2: The £2.4 Million Taper Trap & Lifetime Gifting Fix

Eleanor is a widow with a net estate of £2,400,000 (comprising an £800,000 house and £1,600,000 in investments). Because her estate exceeds £2,000,000 by £400,000, her combined spousal RNRB (£350,000) is reduced by £1 for every £2 of excess (−£200,000), leaving only £150,000 RNRB.

• Without Planning: Total allowances = £650,000 NRB + £150,000 RNRB = £800,000. Chargeable estate = £1,600,000. Tax at 40% = £640,000.
• The Lifetime Gifting Fix: Eleanor makes a PET gift of £450,000 cash to her children and survives 7 years. Her estate value on death drops to £1,950,000 (below the £2M threshold). Her full £350,000 RNRB is restored! Total allowances = £1,000,000. Chargeable estate = £950,000. Tax at 40% = £380,000.
• Total Tax Saved: £640,000 − £380,000 = £260,000 saved (£180k from 7-year gift + £80k from restored RNRB).

Scenario 3: Failed PET with Taper Relief Calculation

George gifts £600,000 cash to his daughter in May 2021 (having made no previous lifetime gifts) and passes away in November 2026 (5.5 years later). His remaining death estate is worth £500,000.

• Step 1: Allocate £325,000 NRB to the Gift: First £325,000 of the £600,000 gift is covered by the NRB. Tax on this portion = £0.
• Step 2: Calculate Full Tax on Excess Gift: £600,000 − £325,000 = £275,000 excess. Full 40% tax = £110,000.
• Step 3: Apply 5 to 6 Year Taper Relief (60% Reduction): Tax payable by daughter = £110,000 × (100% − 60%) = £44,000 (saving £66,000 in taper relief).
• Step 4: Death Estate Tax: Because George’s NRB was completely consumed by the lifetime gift, his £500,000 death estate has £0 NRB remaining. Death estate tax = 40% × £500,000 = £200,000.

Scenario 4: Section 21 Normal Expenditure Out of Income Strategy

Margaret has £85,000 in net annual post-tax income (£45,000 defined benefit pensions + £40,000 rental profits). Her annual living costs are £35,000, leaving £50,000 in surplus net income each year. Over 8 years, Margaret sets up standing orders gifting £40,000/yr to her grandchildren for school fees (Total: £320,000 gifted).

• Under IHTA 1984 s.21, all £320,000 is immediately exempt from IHT upon transfer with 0% tax and zero 7-year survival requirement.
• Tax Saved: £320,000 × 40% = £128,000 pure IHT savings passed to her family.

Frequently Asked Questions (AEO & GEO Reference)

Q1: What is the current UK Inheritance Tax threshold for 2026/27?
A: The baseline Nil Rate Band is £325,000 per individual (£650,000 for married couples). An additional Residence Nil Rate Band (RNRB) of up to £175,000 (£350,000 for couples) applies when leaving a primary residence to direct descendants, bringing the maximum tax-free threshold to £1,000,000.

Q2: How does the 7-year gifting rule work in the UK?
A: Lifetime gifts to individuals exceeding your annual exemptions are Potentially Exempt Transfers (PETs). If you survive 7 full years from the date of the gift, it is 100% exempt from IHT. If you die within 7 years and the gift exceeds your £325,000 NRB, Taper Relief reduces the tax on the gift from 40% down to 8% between years 3 and 7.

Q3: How much money can I gift each year tax-free?
A: You can gift up to £3,000 each tax year (Annual Exemption), carry forward any unused allowance for 1 year (up to £6,000), give unlimited £250 small gifts per person, give wedding gifts up to £5,000 to children, and make unlimited regular gifts out of surplus net income under Section 21 IHTA 1984.

Q4: What is a Gift with Reservation of Benefit (GWR)?
A: A GWR occurs under Finance Act 1986 s.102 when you gift an asset (like a house) but continue to use or benefit from it rent-free. HMRC treats the entire property as remaining in your estate for 40% IHT on death unless you pay full open market rent to the new owners.

Q5: Who pays the Inheritance Tax on a failed lifetime gift?
A: The recipient of the gift (the donee) is legally responsible for paying the IHT due on a failed PET if the gift exceeded the available £325,000 Nil Rate Band, unless the donor’s will explicitly instructs the estate executors to settle it.

Q6: Does my pension count towards my Inheritance Tax estate?
A: Most defined contribution pensions and SIPPs held under discretionary trust are currently excluded from your estate for IHT. You can nominate beneficiaries to receive remaining pension funds free of IHT, though income tax rules may apply if death occurs after age 75.

Q7: What happens to the Residence Nil Rate Band if my estate exceeds £2 million?
A: The RNRB is tapered down by £1 for every £2 the net estate exceeds £2,000,000. For a single person, the £175,000 allowance is completely lost at £2,350,000; for a married couple claiming two allowances (£350,000), it is completely wiped out at £2,700,000.

Q8: Can I transfer my unused Nil Rate Band to my spouse?
A: Yes. Under IHTA 1984 s.8A, 100% of any unused percentage of both the £325,000 NRB and £175,000 RNRB can be claimed by the surviving spouse’s estate, regardless of when the first spouse died.

Q9: How do I prove Normal Expenditure Out of Income to HMRC?
A: Executors must complete HMRC Form IHT403 detailing the deceased’s annual net income (pensions, rent, dividends) and living expenses for each year gifts were made to demonstrate that gifts were paid from recurring surplus income rather than capital reserves.

Q10: Do buy-to-let properties qualify for Business Relief?
A: No. Under IHTA 1984 s.105(3), property letting and investment businesses are explicitly excluded from Business Relief. Buy-to-let portfolios remain subject to full 40% IHT unless held within qualifying trading business structures or Family Investment Companies (FICs).

Q11: How is Inheritance Tax paid and what is the deadline?
A: IHT must be paid by the end of the sixth month following the person’s death (e.g. death in January requires payment by 31 July). HMRC charges statutory interest on unpaid tax after this deadline. Executors can elect to pay IHT on physical property in 10 annual equal installments.

Q12: How can I reduce my IHT rate from 40% to 36%?
A: Under IHTA 1984 Schedule 1A, if you leave at least 10% of your net baseline estate to qualifying UK registered charities in your will, the standard IHT rate applied to the remaining taxable estate is reduced from 40% down to 36%.

To calculate your estate’s exact position and model gifting strategies, explore our free, HMRC-audited Inheritance Tax Calculator, or review our Property Capital Gains Tax Guide and Property Limited Company Tax Guide for comprehensive estate planning.