Inheritance Tax 7 year rule: how gifts and PETs are taxed

The Inheritance Tax 7 year rule determines how many lifetime gifts are treated for Inheritance Tax (IHT) when the person making the gift dies. The broader relationship between gifts and Inheritance Tax means most outright gifts to individuals are not immediately subject to IHT and are normally treated as Potentially Exempt Transfers (PETs).

If the donor survives for seven years after making a qualifying PET, the gift will normally become exempt from Inheritance Tax. If the donor dies within seven years, however, the gift may need to be considered when calculating the IHT position.

The rules are particularly important for people giving substantial amounts of money, property or investments to family members. Gifting sits within the wider Inheritance Tax and estate planning framework explained in our ultimate guide to personal tax in the UK. This guide explains the 7 year rule for gifts, how Potentially Exempt Transfers work, when taper relief may apply and why continuing to benefit from a gifted asset can prevent the normal seven-year treatment from working as expected.

What is the Inheritance Tax 7 year rule?

The Inheritance Tax 7 year rule applies to many gifts made by one individual to another during their lifetime.

Broadly, if a qualifying gift is made and the donor survives for at least seven years, the gift normally falls outside the estate for Inheritance Tax purposes.

If the donor dies within seven years, the gift may become relevant to the IHT calculation.

The seven-year period runs from the date the gift was made to the date of the donor’s death. This makes accurate records of significant lifetime gifts particularly important.

How Potentially Exempt Transfers work

Most outright gifts from one individual to another are treated as Potentially Exempt Transfers, commonly referred to as PETs.

Examples can include:

• Giving a substantial cash amount to an adult child.
• Transferring shares to a family member.
• Giving property outright to another individual.
• Providing a large financial gift towards a child’s house purchase.

A PET does not normally create an immediate Inheritance Tax charge when it is made.

If the donor survives seven years, the PET normally becomes fully exempt. If the donor dies sooner, the transfer becomes a failed PET and must be considered as part of the PET Inheritance Tax calculation.

What happens if you die within seven years?

If the donor dies within seven years of making a PET, the gift does not automatically face a 40% tax charge.

The calculation depends on factors including:

• The value of the gift.
• Any available exemptions.
• Other gifts made during the seven-year period.
• How much of the available Nil Rate Band has already been used.
• How long the donor survived after making the gift.

Earlier gifts are generally considered before later gifts when determining how the available Nil Rate Band is used.

This means several gifts made over a number of years may interact with each other when the final Inheritance Tax position is calculated.

How taper relief works

Taper relief can reduce the Inheritance Tax payable on certain lifetime gifts where the donor survives for more than three years but less than seven years after making the gift.

The effective rates on taxable amounts can broadly be:

• Less than 3 years: 40%.
• 3 to 4 years: 32%.
• 4 to 5 years: 24%.
• 5 to 6 years: 16%.
• 6 to 7 years: 8%.
• 7 years or more: qualifying PET normally exempt.

However, taper relief does not reduce the value of the original gift. It reduces the tax attributable to a gift where tax is actually due.

If the gift falls within the available Nil Rate Band, taper relief may provide no additional benefit because there may be no tax directly payable on that gift in the first place. It’s worth checking the current IHT gift reliefs alongside taper relief, since the two work quite differently despite both relating to timing.

Gifts with reservation of benefit

The normal 7 year rule for gifts may not achieve the intended result where the donor gives an asset away but continues to benefit from it.

This is known as a gift with reservation of benefit.

Examples can include:

• Giving a home to your children but continuing to live there rent-free.
• Giving away a holiday property while continuing to use it without charge.
• Giving away valuable artwork while continuing to keep and enjoy it in your home.

In these circumstances, the asset can remain within the donor’s estate for Inheritance Tax purposes even if more than seven years have passed since legal ownership was transferred.

Simply transferring ownership is therefore not always enough to remove an asset from the estate.

Worked example: the 7 year rule for gifts

David gives £200,000 to his daughter as an outright cash gift.

After applying any available exemption, the remaining qualifying amount is treated as a Potentially Exempt Transfer.

If David survives for seven years after making the gift, it would normally become exempt from Inheritance Tax.

If David dies four years after making the gift, the transfer must instead be considered when his estate is administered.

Whether any IHT is actually payable on the gift depends on David’s available Nil Rate Band and other relevant lifetime transfers. If tax is attributable to the gift, taper relief may reduce that tax because he survived for more than three years.

Keeping records of lifetime gifts

Good records are essential when dealing with Inheritance Tax on lifetime gifts.

For significant gifts, retain details of:

• The date the gift was made.
• The recipient.
• The amount or asset transferred.
• The value of the asset at the date of the gift.
• Any exemption applied.

Executors may need this information years later when administering the estate. This is especially true where a gift was intended to qualify under the IHT exemption for normal expenditure out of income, since that relief depends heavily on documented patterns of giving.Without accurate records, establishing which gifts fall within the seven-year period, including any regular gifts paid out of disposable income, and how they should be treated can become difficult.

Key takeaways

The Inheritance Tax 7 year rule means that many outright lifetime gifts to individuals can become exempt from IHT when the donor survives for at least seven years after making them.

Where death occurs sooner, Potentially Exempt Transfers may need to be brought back into the Inheritance Tax calculation. Taper relief can reduce tax attributable to certain gifts after three years, but it does not simply reduce the value of every gift.

It is also important to consider gifts with reservation of benefit. Giving an asset away while continuing to use or benefit from it can mean that the asset remains within the estate despite the passage of seven years.

Keeping clear records of significant gifts helps executors apply the PET Inheritance Tax rules correctly and determine the appropriate treatment when the estate is administered. Alongside lifetime gifting, giving money to charity in your will is another established way to reduce an estate’s overall Inheritance Tax exposure.

Case Study: Checking How Earlier Family Gifts Fall Within the Seven-Year Rule

A telephone enquiry came into our Wimbledon office from a family whose father had made several substantial cash and investment gifts to his children over different years. They wanted to understand how the Inheritance Tax 7 year rule applied to each transfer, whether the gifts were Potentially Exempt Transfers and what information the family should retain so the correct position could eventually be established.

Our advisers reviewed the dates, recipients and values of the lifetime gifts and considered how each transfer would be treated under the PET Inheritance Tax rules. We explained how the seven-year period runs separately from the date of each qualifying gift, why earlier transfers can affect the available Nil Rate Band and when taper relief may become relevant if death occurs between three and seven years after a gift. We also highlighted that taper relief reduces tax attributable to a qualifying gift rather than reducing the original value of the gift itself. Alongside the review, we provided Inheritance Tax planning, estate planning guidance, personal tax advice, Capital Gains Tax planning for transferred investments and succession planning support. We also helped the family organise records of the historic gifts so future executors would have clearer evidence when administering the estate.