Loan deductions and IHT

Within a death estate and an IHT400 account, the value of liabilities can generally be deducted when calculating the IHT liability (under IHTA 1984, s 5(5)). Debts which are allowable for inheritance tax (IHT) purposes have to be either debts imposed by law (tax being the most common, but also local taxes such as council tax, and fines), or debts which the deceased purchased for money or money’s worth. One criterion is that the debts must be legally enforceable (unless statute-barred, including student loans) – they cannot be loans which might only be morally enforceable or if there is no written evidence. Another criterion is that the debt was actually to be repaid by the estate unless there was a good commercial reason and the main purposes (or one of them) for leaving the loan unpaid was not to secure a tax advantage. It’s not just loans that are deductible, but liabilities more generally; so this can include things such as utility bills, professional fees, gambling debts (as long as the gambling is legal!) and uncashed cheques.

Restrictions on deductions

One of the restrictions on the deduction of  liabilities puts to an end a common piece of deathbed planning; a loan is raised against an asset which does not qualify for agricultural property
relief (APR) or business property relief (BPR) or woodlands relief (e.g., the main residence), the resulting cash is invested into an asset which does potentially qualify – the business, the farm.

As long as that business or farm has been trading for at least two years, that cash will normally form part of the activity and be instantly covered by agricultural or business property relief.
Simultaneously, the value of the house would be reduced by the value of the secured loan such that only the equity in the house is chargeable to IHT. However, for deaths on or after 17 July 2013 and liabilities incurred on or after 6 April 2013, the value of that liability would not be set against the house but against the business or farm – thus wasting the benefit of the offset.

The same applies to unsecured loans which are offset against the value of the estate – not just a particular asset like a house. The rules introduced in Finance Act 2013 apply to any monies borrowed to acquire, maintain or enhance ‘excluded property’ (i.e., that are outside the scope of UK IHT) or assets that qualify for APR or BPR or woodlands relief, and where the liability is not repaid or discharged out of the estate.

‘IOU’ debts

There have been instances of schemes whereby liabilities are created by an individual who sells their home to a trust in return for an IOU promissory note, the value of which is eventually offset against the value of their estate. HMRC opposes these schemes on various grounds, one of which is under FA 1986, s 103 on the basis that the liability is artificial and the consideration for the
debt derives from the deceased.

In a case with these facts pre-dating the ‘pre owned assets’ income tax regime introduced in 2004, HMRC’s challenge against such an IOU scheme in Shelford v HMRC [2020] UKFTT 53.

There were issues concerning gifts with reservation of benefit in this case, which was defeated on the grounds that the disposition was void and so the value remained in the deceased’s estate.
Nonetheless, the effect of IHTA 1984, s 103 was explored within the case and gave effect to HMRC’s view of such schemes contained in HMRC’s Inheritance Tax Manual at IHTM44106.

However, this section was very recently considered in HMRC v Elborne [2026] EWCA Civ 894, where the Court of Appeal held that section 103 did not apply to this situation; the promissory note was not a debt incurred by the deceased. It will be interesting to see how HMRC’s interpretation of such schemes might change following Elborne.

Practical tip

If liabilities are to be left outstanding, proper consideration should be given as to on what basis the deduction is being made.