How family heirlooms can reduce your inheritance tax bill

With inheritance tax revenues at a record £7bn high, families are doing everything they can to avoid the punitive 40pc charge.

If an estate is worth more than the nil-rate band of £325,000, then any value above this will be subject to death duties. 

An estate includes property, cash and personal possessions – including any antiques, jewellery and art collections they owned.

However, families lucky enough to inherit an artwork or treasure that is considered “pre-eminent” may be able to claim a tax exemption – removing the painting, sculpture or book from the estate and slashing their inheritance tax bill. 

Pre-eminent art can also be used to pay some or all of an inheritance tax bill through the “Acceptance in Lieu” scheme. 

In 2021-22, a Jane Austen letter, a landscape painted by David Hockney and the medals of Field Marshal Lord Alanbrooke were all accepted under the scheme and used to pay off a family’s tax bill.

Here, Clarissa Levi of art consultancy Bailey Heaven Levi, explains what qualifies as “pre-eminent” and how families can use their precious heirlooms to cut their tax bill.

Tax incentives for important works of art and cultural property exist to preserve the national heritage by encouraging owners to retain it in private hands where possible and to share it publicly. 

When owners must sell their heritage art, or archives or libraries, there is an incentive to do this by a tax-free sale to a museum.

HM Revenue and Customs guidance on capital taxation and the national heritage states: “Objects and collections of national, artistic, historic or scientific interest form an integral and major part of the cultural life of this country... For more than a century a succession of fiscal and other measures have been introduced to help preserve the heritage”.

So how can family heirlooms reduce your family’s inheritance tax bill?

Conditional Exemption

Conditional exemption from IHT encourages us to hold onto our heritage property in private ownership while sharing it with the public.

When an object is conditionally exempted from IHT which would otherwise be payable, no IHT arises so long as the owner keeps certain promises: to keep the property in the UK, safe and in good repair, and share it with the public, including allowing access to it without a prior appointment, and crucially, not to sell it or give it away. 

Public access to conditionally exempted property can sometimes be provided by opening the house where the object is kept. 

In most cases, though, this isn’t an option, so providing public access will often mean lending your work of art to a museum where it can be displayed for the necessary number of days per year, usually a minimum of 28.

The exemption is conditional because it is lost, and tax is charged, if the conditions cease to be met – if the owner dies (when the exemption must be claimed anew) or fails to allow the promised public access or sells the property. 

There is no benefit in having an object conditionally exempted only for it to be sold a few years later. The incentive is for family heirlooms to be kept in the family’s hands through the generations.

Not all art will qualify. The bar is high – paintings, books, objects of scientific or historic significance and indeed collections or groups of art, must be considered pre-eminent to be eligible. 

This could be because of how closely they are associated with our history and national life, or because of their artistic or art-historical importance or their importance for scholarship, or because they have a particularly close association with a historic setting.

A lower threshold applies to objects associated with some historic buildings which themselves will usually be open to the public. 

So, the UK’s national heritage ranges from the most venerated of old master paintings down to a coal scuttle in a stately home. 

By allowing much of the contents of a historic house to pass down the generations free from IHT, the visitor experience becomes livelier and more enlightening. 

The furniture, art and decorative objects speak of how life in a house was lived, in contrast to an empty shell whose contents have been sold to pay death duties.

Acceptance in Lieu

The AiL scheme allows anyone with an inheritance tax bill to pay it partially or in full using heritage property. 

The threshold for eligible objects is again high. Objects accepted via AiL must be pre-eminent, but can be delightfully varied. 

Accepted objects have included every kind of art, through to medical instruments, meteorites, and a steam locomotive among other curiosities and treasures.

The property is offered to the Secretary of State for DCMS or the appropriate Minister in Wales or Scotland, and if it is accepted, it will be allocated to an appropriate library, museum or gallery, or a charity like the National Trust, for public display. 

An offer in lieu can only be made by whoever is liable to pay the tax.

As with any tax incentive, AiL benefits the offeror because ultimately if the offer is accepted, tax is forgone by the treasury – up to a maximum of £40m each year including Cultural Gifts Scheme contributions. 

In 2021-22, tax of £27.5 million was settled via the AiL Scheme and the CGS, resulting in objects worth a total of just under £60 million being accepted into public collections.

The effect of the heritage incentives can be seen in the example of an estate where an IHT bill at a rate of 40pc arises after parents have died leaving their daughter a valuable house and its contents. 

Among their possessions is a pre-eminent family portrait worth £100,000.

After the Nil Rate Band, the daughter has options to mitigate her IHT bill. If she sells the family portrait, the net proceeds after IHT will be £60,000 which she can use to settle tax.

Alternatively, if she seeks conditional exemption, IHT won’t arise on the picture so her overall tax bill will be £40,000 less. She will still own the painting, but from now on it will be on loan to her local art gallery.

If instead she successfully offers the portrait through AiL, not only will the painting itself be IHT-free, so her overall tax bill will be similarly reduced, but the tax credit arising from the AiL is more than the £60,000 from a sale because an incentive known as the douceur, or sweetener, is applied.

In calculating the tax credit, the notional IHT which would have arisen on the £100,000 painting is £40,000. One quarter of this notional tax, the douceur, is remitted to the estate meaning that the painting now has a tax settlement value of £70,000.

The benefits to the daughter do not end there. Interest on the IHT bill ceases to run, to the extent of the anticipated tax credit, from the moment she makes the offer. 

At current rates this is no small consideration. And if interest still arises elsewhere in the estate, the tax credit from the AiL can be used to meet not just the IHT liability itself, but also that interest.

Variants on AiLs have evolved. HMRC cannot accept a part-share in an object, and it cannot give change if an object is more valuable than the IHT bill. 

However, in some circumstances a part-AiL and part-sale can be negotiated where an institution agrees to pay the difference between the tax bill and the tax credit.

There are also rare situations in which objects remain in their current location, so long as public access can still be provided and a partner institution agrees to participate. 

“In situ” AiLs allow pre-eminent objects to be accepted and then viewed by the public in the location for which they were created, or with which they are so closely associated that they have an additional significance from being seen in that context.

Conditionally exempting art or offering it in lieu of tax can have a dramatic effect on overall IHT.

These incentives explain why many of this country’s historic collections have survived and are now open to the public. As IHT continues to arise in increasing numbers of estates, tax planning around art will grow in importance too.