Potentially Exempt Transfers (PETs) Explained
Understanding the 7-year rule, taper relief, and strategic gift planning
Key Points
- • PETs are gifts to individuals (not trusts) during your lifetime
- • Become completely exempt if you survive 7 years after making the gift
- • Taper relief reduces tax if you survive more than 3 years
- • No immediate tax charge when you make the gift
What is a Potentially Exempt Transfer?
A Potentially Exempt Transfer (PET) is a lifetime gift to an individual that becomes fully exempt if the donor survives 7 years from the date of the gift. If the donor dies within 7 years, the PET fails and is brought into the Inheritance Tax (IHT) calculation on death.
Qualifies as PET:
- • Cash gifts to individuals
- • Property given to family members
- • Shares transferred to children
- • Assets given to friends
- • Payments of someone else's bills
Not a PET:
- • Gifts to trusts (usually chargeable)
- • Gifts to companies
- • Gifts to charities (fully exempt)
- • Gifts between spouses (exempt)
- • Annual exemption gifts
The 7-Year Rule
If you survive 7+ years:
The gift becomes completely exempt from inheritance tax. It's removed from your estate for tax purposes and doesn't count towards the recipient's inheritance tax liability.
If you die within 7 years:
The gift is added back to your estate for inheritance tax calculation. However, taper relief may reduce the tax charge if you survived more than 3 years.
Taper Relief
Taper relief (what it actually reduces)
Taper relief reduces the tax, not the gift's value. It applies only where a failed PET exceeds the available nil rate band (NRB) and tax would otherwise be payable. If there's no tax (because the failed PET is covered by NRB), no taper applies.
Typical rates: 3–4 years 20% reduction in tax due; 4–5 years 40%; 5–6 years 60%; 6–7 years 80%.
| Years Survived | Tax Rate | Relief |
|---|---|---|
| 0-3 years | 40% | No relief |
| 3-4 years | 32% | 20% relief |
| 4-5 years | 24% | 40% relief |
| 5-6 years | 16% | 60% relief |
| 6-7 years | 8% | 80% relief |
| 7+ years | 0% | 100% relief |
Order of calculation at death
On death, failed PETs are dealt with before the estate, using up the NRB in date order. Only after allocating NRB to failed PETs do you apply any remaining NRB to the estate.
Heads-up: the "14-year effect"
If there was a Chargeable Lifetime Transfer (CLT) (e.g., into a discretionary trust) within the 7 years before a later PET, and death occurs within 7 years of that PET, HMRC may need to look back up to 14 years when allocating the NRB (CLT first, then PETs, then the estate).
Exemptions at a Glance
- Annual exemption — £3,000 (with one-year carry-forward if unused).
- Small gifts — £250 per person (cannot be combined with the annual exemption for the same recipient in the same tax year).
- Normal expenditure out of income — regular, out of income, and without reducing your usual standard of living.
Keep records to evidence amounts, dates, recipients, and (for the income exemption) income vs. expenditure.
Caution — GWR and POAT
If you give an asset but continue to benefit from it (e.g., give away a home but keep living there without paying full market rent), the gift can be treated as a gift with reservation (GWR) and the value may be pulled back into the estate. In some cases POAT (Pre-Owned Assets Tax) may apply instead. Take advice before gifting assets you still use.
RNRB interaction
The Residence Nil Rate Band (RNRB) £2m taper is based on the value of the estate at death. Lifetime gifts (PETs) are not part of the estate value for this taper test (though failed PETs still use up the basic NRB).
Worked Examples
Scenario: Donor made a £200,000 PET 6 years before death and a £150,000 PET 2 years before death; estate £400,000; NRB £325,000.
- • Apply NRB to failed PETs in date order: £200k uses £200k NRB
- • £125k NRB remains for the £150k PET → £25k of that PET exceeds NRB and is taxable
- • Taper applies only to the tax on £25k, at the 2–3 year band (no reduction — 40% rate)
- • Tax on £25k = £10,000
- • Any remaining NRB (here £0) then applies to the estate; the estate is taxed accordingly (subject to any spouse/charity reliefs)
Scenario: If total failed PETs are within NRB, there is no IHT on gifts and no taper — the estate then uses any remaining NRB.
For example, if failed PETs total £200,000 and NRB is £325,000, the gifts use £200k of NRB, leaving £125k for the estate. No tax on the gifts, and taper relief doesn't apply because there's no tax to reduce.
Scenario: John gives his daughter £500,000 in 2020. He dies in 2025 (5 years later). His estate is worth £800,000 at death.
Calculation:
- • Total estate for tax: £800,000 + £500,000 = £1,300,000
- • Less nil rate band: £1,300,000 - £325,000 = £975,000
- • Tax at 40%: £975,000 × 40% = £390,000
- • Tax on PET portion: £500,000 × 40% = £200,000
- • Taper relief (60%): £200,000 × 60% = £120,000 relief
- • Final tax on PET: £200,000 - £120,000 = £80,000
Forms & Reporting
Forms & reporting
Report lifetime gifts on IHT403 with the main IHT400. Use date-ordered schedules showing how the NRB is allocated.
Who pays if a PET fails?
In principle the recipient of the gift is liable for any IHT attributable to that gift, though in practice personal representatives may settle and adjust via the will or recovery.
Strategic Gift Planning
- • Make gifts as early as possible
- • Use annual exemptions first (£3,000 per year)
- • Consider regular gifts from income
- • Keep detailed records of all gifts
- • Consider the recipient's tax position
- • You must genuinely give up control
- • Consider your own financial security
- • Impact on means-tested benefits
- • Capital gains tax on gifted assets
- • Family relationship dynamics