The Seven-Year Rule and Taper Relief Explained

Giving assets away during your lifetime is one of the most effective ways to reduce a future inheritance tax bill, but the benefit depends on how long you survive the gift. This is the seven-year rule, and alongside it sits taper relief, probably the most misunderstood feature in the whole of inheritance tax.

This article explains both clearly. It is part of our guide to Lifetime Gifting and the Seven-Year Rule. If you want a gifting strategy built around your own circumstances, our lifetime gifting service at /services/lifetime-gifting can put a plan in place for you.

Potentially exempt transfers

Most gifts from one individual to another are potentially exempt transfers, often shortened to PETs. A potentially exempt transfer is free of inheritance tax provided the person making it survives for seven years. If they survive the full seven years, the gift falls out of the estate entirely and is never taxed. If they die within seven years, the gift is brought back into the calculation.

The word potentially is the key. At the time of the gift you do not know whether it will end up exempt, because that depends on survival. Only the passage of seven years makes it certain.

How gifts are set against the nil-rate band

When someone dies within seven years of making gifts, those gifts are added back and set against the nil-rate band first, in chronological order, oldest first. This matters because it means earlier gifts use up the nil-rate band before later ones, and tax only becomes payable on gifts once the cumulative total exceeds the available nil-rate band of £325,000.

A gift that falls entirely within the nil-rate band carries no tax of its own, even if death occurs within seven years. It does, however, reduce the nil-rate band available to the rest of the estate.

What taper relief actually does

Here is the point that trips most people up. Taper relief reduces the tax payable on a gift, not the value of the gift itself. And it only applies where the cumulative gifts exceed the nil-rate band, so that there is actually tax to taper in the first place. If the gifts fall within the nil-rate band, there is no tax, and therefore nothing for taper relief to reduce.

This is why people are sometimes surprised to find that taper relief gives them no benefit at all. If the total gifts are below £325,000, the gift is already covered by the nil-rate band and taper relief never comes into play.

The taper relief sliding scale

Where taper relief does apply, it reduces the tax on the gift on a sliding scale according to how long the donor survived after making it. There is no reduction in the first three years. The reduction then increases each year up to the seven-year point, at which the gift drops out of the calculation entirely.

So a gift that has tax to pay and was made between six and seven years before death is taxed at the equivalent of 8 per cent rather than 40 per cent, because the tax is reduced by 80 per cent. Survive the full seven years and the gift is ignored altogether.

A worked illustration

Suppose an individual gives £500,000 to a child and dies four and a half years later, having made no other gifts and with the full nil-rate band available. The first £325,000 of the gift is covered by the nil-rate band. The remaining £175,000 is taxable. Tax at 40 per cent would be £70,000, but because death occurred between four and five years after the gift, taper relief reduces that tax by 40 per cent, leaving £42,000.

Note that because the gift used the whole nil-rate band, the rest of the estate has no nil-rate band left and is taxed from the first pound. This interaction is exactly why large gifts need to be planned rather than made on impulse.

Practical points to keep in mind

• Keep clear written records of every significant gift, including the date, the amount, and who received it.
• A gift where you keep a benefit, such as giving away a house but continuing to live in it rent-free, is a gift with reservation of benefit and is treated as still in your estate.
• Taper relief never reduces the value brought into the estate; it only reduces the tax, and only above the nil-rate band.
• Annual and small-gift exemptions, covered in our gifting guide, can remove smaller gifts from the seven-year clock altogether.
• The seven-year clock runs separately for each gift, so a programme of regular gifting builds up multiple clocks over time.

Common questions

If I survive seven years, is the gift definitely tax-free?

For a normal outright gift with no benefit retained, yes. Surviving seven years takes the gift out of the estate. The main exception is a gift with reservation of benefit, which stays in the estate regardless of how long you live.

Does taper relief help with a small gift?

Usually not. Taper relief only reduces tax, and a gift within the £325,000 nil-rate band has no tax of its own, so there is nothing to taper. The benefit of small gifts comes from the annual exemptions and from simply surviving the seven years.

What happens to the nil-rate band if I make several gifts?

Gifts use the nil-rate band in date order, oldest first. Later gifts and the eventual estate get whatever band is left. Planning the timing and size of gifts is how a specialist keeps the most value within the band.