The Conservatives have proposed scrapping inheritance tax (IHT) on family homes – but the plans risk causing distortion in the property market, according to experts.
Currently, IHT is applied at a rate of 40 per cent on estates that exceed £325,000 with those passing their primary homes to direct descendants getting an additional £175,000 allowance on top. Married couples also having the ability to pool their allowances together.
Only 1 in 20 estates pay IHT but from April 2027, pensions will be included in a person’s estate when IHT is calculated, meaning those with large homes and pension pots may end up paying the tax.
This week, Badenoch told the Conservatives’ annual conference that she would increase the £325,000 threshold – the point at which you start paying the tax – to £500,000 and fully exempt family homes from IHT too.
Despite Badenoch stating the plans would see the number of families paying the tax fall by half, experts have warned the proposal gives wealthy pensioners the incentive to hold on to their homes and even buy bigger homes in a bid to cut their tax bill.
Pressure on the housing market
Ian Dyall, head of estate planning at Evelyn Partners, said the policy risks encouraging people to buy larger properties than they need and then hold on to them in retirement rather than downsize.
This is because tying up wealth in a home, rather than in other assets, means someone’s estate could attract a lower IHT bill.
He added: “Such a policy could reduce the supply of family-sized homes coming back onto the market, particularly in areas where housing is already in short supply, adding to upward pressure on prices. That would also make it more difficult for younger families to access suitable homes.”
Rebecca Durrant, partner at tax firm Crowe, also highlighted how this raised welfare issues, as elderly people may end up trying to stay in their homes as long as possible – beyond when it is healthy to do so – to ensure they qualify for the tax relief.
Upsizing becomes attractive
Not only could the proposals lead to wealthy pensioners to stay put in their current homes, but it could also spur some to upsize and buy bigger homes before they die to convert cash which would have otherwise have been within the tax net into property that would not be.
Dan Neidle, founder of Tax Policy Associates, said: “The proposal gives wealthy pensioners a powerful reason to buy bigger houses. If you sell investments, and put the money into your home, then your children could save 40p in tax for every £1 you spend. If you downsize, on the other hand, every £1 of house value you sell could increase IHT by 40p.”
Neidle estimates the proposals could shift between £60bn – £110bn from savings and investments into housing and reduce the number of £1m-plus homes coming onto the market in London and the Southeast by 3 per cent – 6 per cent each year.
He added: “Around 90 per cent of the tax cut would go to the wealthiest fifth of pensioner households.”
Dyall said the proposal could make people view housing as a tax-efficient way to pass on wealth and favour it over other assets like investments or pensions.
Closure of Bank of Mum and Dad
With rising living costs, increasing numbers of parents and grandparents are financially supporting their adult children.
Research from law firm Morr & Co found 84 per cent of pre-retirement UK homeowners aged 50-66 expect to provide financial support to younger generations during their retirement.
With pensions also coming into the scope of IHT from next year, more people are looking to gift money during their lifetime to reduce their tax liability before April 2027.
People must survive seven years after making a gift in order for it to be tax-free. Gifts given three to seven years before death get some tax relief, but not 100 per cent.
However, Nimesh Shah, chief executive of Blick Rothenberg said the policy might encourage more people to potentially hold on to the money they were planning to gift, and instead put it into their home.
He added: “From a Bank of Mum and Dad perspective, what does that mean for younger people wanting to get onto the housing ladder? We’re trying to encourage more social mobility in this country.
“We’re actually creating an incentive now for older people to hold on to their homes and not move out and put more money into them.”
Shah was sceptical whether the Tories would be able to pull off such a policy given IHT brings in around £9bn of revenue to the government and they would not be able to afford such a tax cut.
However, he suspected a cap on the value of the home would be introduced and second homes would not qualify.
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