An interest free loan to a child that is repayable on demand is not a transfer of value for Inheritance Tax, so nothing is taxed when it is made, but the full amount owed stays in the parent’s estate and is taxed on death. Writing the loan off turns it into a gift that runs on the seven year rule, and in England and Wales the release only works if it is made by deed.

Is an interest free loan a gift for Inheritance Tax?

Not in any sense that produces a tax charge. HMRC’s Inheritance Tax Manual at IHTM14317 says the grant of an interest free loan repayable on demand is not a transfer of value, because the right to repayment is worth the amount lent. The parent swaps cash for a debt of the same value, so the estate does not fall.

The same page says the loan is still a gift in a narrow sense, because the parent is giving up the interest they could have charged. That forgone interest does not itself create a charge, and HMRC accepts that making the loan is not, on its own, a gift with reservation. The special rules for loans to trustees are different; see loan trusts and discounted gift trusts.

Why lend instead of giving?

A loan does not reduce the estate, so it is not a way of saving tax on the amount lent. What it does is freeze that amount. If the child buys a home or invests the money and it grows, the growth belongs to the child and never forms part of the parent’s estate. The parent can also call the money back if they need it, or if the child’s circumstances change.

A gift works the other way round: the cash leaves the estate straight away but only escapes tax once the parent survives seven years. Families often combine the two, lending a large sum and then releasing part of it each year. Our page on gifting a house deposit compares the routes for a property purchase.

How is the debt valued when the parent dies?

Section 166 of the Inheritance Tax Act 1984 says a right to receive a sum is valued on the assumption that it will be paid, unless recovery is impossible or not reasonably practicable and has not become so through the creditor’s own act or omission. HMRC’s manual at IHTM19010 therefore expects the full outstanding capital, plus any interest due at death, to be included as an asset of the estate.

A lower figure is accepted only with an explanation of why the money could not have been repaid and how the reduced figure was worked out, backed by evidence. A child who simply has the money tied up in a house is not enough on its own, because they could usually sell or borrow. If the debt has been reduced because the parent chose to give up part of it, that part no longer exists in the estate, but the release may itself be a chargeable gift (IHTM19100).

The terms of the loan also count. IHTM19070 says that where the loan cannot be called in on demand, or can be repaid later or by instalments, it has to be valued under section 160 at its open market value, and HMRC refers the valuation to its actuaries. A simple loan repayable on demand avoids that argument.

What do executors have to report?

Executors list debts owed to the deceased on form IHT416, which goes with the full IHT400 account. IHTM19050 shows what HMRC expects on the form: the date and amount of the original loan, the capital and interest outstanding at death, who borrowed the money and their relationship to the deceased, any interest charged, any capital repaid, and evidence that the loan existed, such as a signed letter or a mortgage deed. Where there is no written evidence, the executors must describe the terms, including whether the loan was repayable on demand.

HMRC also checks whether any repayments or releases during the parent’s life were recorded properly, either as gifts or as money returned to the estate (IHTM19080). A short loan note signed by both parties when the money is paid saves a great deal of work later. See completing the IHT400 for the wider return.

How do you write the loan off properly?

In England and Wales a debt cannot be released by a letter or a conversation. HMRC’s manual at IHTM19100 and IHTM19110 explains that a voluntary release given for nothing in return must be made by deed, otherwise it is void and the debt can still be enforced. Letters and other evidence showing an intention not to ask for the money back are not enough. Since 31 July 1990 a deed must make clear that it is intended to be a deed and be validly executed, usually by signature, under section 1 of the Law of Property (Miscellaneous Provisions) Act 1989.

Scotland is different: IHTM19100 confirms a release there can be made by informal writing or verbally.

Once a release is effective, the amount written off is a gift (IHTM19080). It is a potentially exempt transfer, so it falls out of account if the parent survives seven years, and executors report it on form IHT403. The annual exemption of £3,000 per tax year, with one year’s carry forward, can cover part of a release. Releasing a slice of the loan each year by deed is a common way of using that exemption; see the annual exemption.

What if the will forgives the loan?

Forgiving a loan in a will does not take it out of the estate. GOV.UK explains that anything left in a will is not a gift but part of the estate. The debt is still valued in full under section 166 as an asset, and the forgiveness simply decides who benefits from it. If the parent wants the amount outside the estate, the release has to happen during their lifetime and they need to survive seven years; see the seven year rule.

How might this work in practice?

Illustration only. Priya lends her son £100,000, interest free and repayable on demand, and they both sign a short loan note. He buys a flat. Each April Priya signs a deed releasing £3,000 of the loan, covered by her annual exemption. She dies six years later. The outstanding £82,000 is an asset of her estate and goes on the IHT416. The £18,000 released is exempt, and any rise in the value of the flat is her son’s and outside her estate.

Had Priya instead released the whole £100,000 in one deed four years before her death, £94,000 (after the annual exemptions for that year and the year before) would have been a potentially exempt transfer that failed, using £94,000 of her threshold.

What mistakes come up most often?

  • No written loan terms, leaving executors unable to show the loan existed or whether it was repayable on demand.
  • Informal write offs by letter or text in England and Wales, which do not release the debt.
  • Assuming forgiveness in a will reduces the estate.
  • Claiming a reduced value because the child could not easily repay, without evidence that recovery was genuinely impossible.
  • Writing off a loan that funded a house the parent later lives in. The exclusion from the pre owned assets charge for outright gifts of money made seven years before occupation does not apply to a loan later written off (IHTM44036).

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.