How are PETs taxed when value falls?
23rd January 2026
Posted in Articles by Forbes Dawson
A potentially exempt transfer (PET) is a gift that will ‘potentially’ be outside a donor’s estate for inheritance tax (IHT) purposes. If the donor survives seven years, then the gift will fall completely outside of the donor’s estate. Otherwise, the approach is as follows:
1. If relevant, deduct any specific IHT relief, Business Property Relief/Agricultural Property Relief.
2. Deduct any available annual gift exemptions from the gift (for example £3,000 annual allowance for the donor).
3. Deduct any available nil rate band for the donor and any ‘inherited’ nil rate band from a predeceased spouse or civil partner.
4. Calculate IHT at 40% on the value remaining.
5. If the donor survived more than three years from the date of the gift, then tapering can apply whereby the tax is reduced by 20% for surviving three years and each additional year thereafter.
So far so good, but what happens if the gift has fallen in value?
Example
Bob gifts a property worth £800,000 to his son, Julian on 10 January 2026 but dies on 1 February 2029. His wife had died on 10 July 2028 and so he ‘inherited’ £325,000 of IHT nil rate band from her. Following the above steps the IHT would be as follows:
1. Deduct £3,000 annual gift exemption.
2. Deduct £650,000 of nil rate bands.
3. Calculate 40% IHT on £147,000, giving £58,800.
4. Apply 20% taper relief to reduce this to £47,040, which is IHT payable by Julian.
But is it? There was one fact that I left out – the property had decreased in value to £500,000 at the date of Bob’s death. In these circumstances ‘fall in value relief’ should be available. This means that £500,000 can be used as the value of the gift rather than £800,000 when calculating the IHT due on the gift. This is only available if the asset is still held, or if any sale took place on arm’s length terms. This would make the tax calculation for Julian as follows (using £500,000):
1. Deduct £3,000 annual gift exemption.
2. Deduct £497,000 of nil rate band.
3. Calculate 40% IHT on £0, giving £0.
4. Julian therefore has no IHT payable.
It’s not all good news though, because the original gift of £800,000 has still used up the nil rate band (there is no restating for this purpose) and so any later PETs and the rest of the estate will be subject to a 40% IHT rate (although tapering may be available in respect of PETs in line with the above methodology).
Forbes Dawson view
This is one example around how the proper IHT treatment of failed PETs can be fiddly. This reminds me of a common misconception around how taper relief applies, with some people thinking that it applies to the value of the gift before applying the nil rate band. The true position is that any gifts that eat up the nil rate band do not benefit from any taper relief at all – even if death occurs six years and 364 days after the date of the gift. Anyway, the fact remains that this is a valuable relief for the donee who will want to consider the value of any assets received in the event of a failed PET. Don’t forget there are even trickier rules when dealing with the fall in value for shares!
