Will I Face Inheritance Tax When Repaying My Daughter’s Loan?

Q. Over 20 years ago, I borrowed money from my daughter, and I intend to repay her with interest upon my passing. Will this incur any inheritance tax, and should we prepare a formal agreement now? Leslie, 75

Whether or not inheritance tax (IHT) is applicable will depend on the size of your estate at the time of your death. Your designated executors—the individuals named in your will responsible for managing your estate—will need to assess the total value of your assets and subtract any debts owed.

If the remaining value exceeds your available tax-free threshold of £325,000, as well as an additional residence allowance of £175,000—which applies if your estate is valued under £2 million and you bequeath your primary residence to a direct descendant—then IHT may be imposed. Be mindful of any allowances you may have inherited from a spouse as well.

Any amount surpassing the available tax-free allowances is typically subject to IHT at a rate of 40%.

Your estate’s liabilities might encompass outstanding debts like mortgages, business loans, or borrowed funds from friends or family. If the original intent was to settle your daughter’s loan from your estate, this debt should be enforced legally.

While you may have an informal verbal agreement regarding the loan, there doesn’t seem to be a documented record of it. Such informal arrangements are common within family transactions; however, a lack of written terms could complicate matters concerning IHT.

For instance, your executors might struggle to substantiate the existence or amount of the loan. Furthermore, the absence of a written contract might raise questions from HM Revenue & Customs (HMRC).

It’s advisable to formalize the loan with a written agreement detailing the specific legal terms. Consider having your daughter hold a charge over your assets to guarantee loan repayment, as this would solidify the validity of the agreement.

Additionally, be cognizant of how interest is computed, as it will be recognized as income for your daughter, requiring her to report it and potentially pay income tax on it upon receipt.

Ultimately, your executors will report the loan details on the IHT submission after your demise, and HMRC might conduct inquiries at that time. A written agreement outlining the loan’s terms and repayment mechanisms would be advantageous.

Kate Aitchison specializes in capital gains tax, inheritance tax, succession planning, investment structuring, and tax residency at the accountancy firm RSM UK.