The ratio of house prices to the inheritance tax (IHT) threshold remains at record levels in most UK regions, according to analysis by PricewaterhouseCoopers. This concludes that, although a gradual house price correction could reduce the IHT burden in the short term, the rising trend could reassert itself in the long run.

The report argues that the Chancellor of the Exchequer could reduce this risk if he continues in the longer term with the policy announced in Budget 2005 of increasing the IHT threshold by more than retail price inflation (RPI) in 2005, 2006 and 2007.

The report notes that, for a great many older people, their homes are their major asset and one that is not easy to shelter from IHT. Since 1997, however, the ratio of average UK house prices (for former owner occupiers) to the IHT threshold has more than doubled from 32% then to around 66% in the second quarter of 2005 (up slightly from 65% a year earlier).

In London, the ratio rose from 49% in 1997 to 103% in 2004 as house prices boomed, although it did then fall back slightly to 101% in the second quarter of 2005. Other UK regions have also seen marked rises in this ratio over the past eight years, potentially drawing an increasing number of people into the IHT net in regions across the UK.

John Hawksworth, head of macroeconomics at PricewaterhouseCoopers and author of the paper, commented: "Our analysis shows that the indexation of the IHT threshold fell well behind the rise in house prices between 1997 and 2004, with the result that ever more people were drawn into the IHT net."

"The Chancellor’s decision in Budget 2005 to over-index the IHT threshold in 2005, 2006 and 2007 was helpful and welcome, but this policy will need to be continued in the longer term to the reduce the risk of a renewed upward creep in the inheritance tax burden."

The analysis shows that the ratio of average house prices to the IHT threshold is now even higher, both nationally and in most UK regions, than it was at the height of the late 1980s boom.

The potential IHT threat that this posed to homeowners was defused in the last cycle by the fact that house prices slumped in the early 1990s, while the IHT threshold was raised sharply in 1996.

The report says it is possible that a similarly sharp house price correction could restore a significantly lower ratio to the IHT threshold again over the next few years, but with interest rates likely to remain relatively low and housing in short supply in many parts of the UK. This is less likely than a more gradual adjustment where house prices grow more slowly than average earnings for a number of years.

Based on this kind of gradual correction scenario for house prices, and an assumption that the IHT threshold is raised in real terms by 0.7% per annum after 2007 (the average for the period 1997-2005), the report projects that the ratio of average UK house prices to the IHT threshold could fall from 66% now to around 56% in 2010, but might then rise gradually again to around 63% in 2020. Alternative high and low variants suggest the ratio could either fall to only 46% by 2020 or rise to as high as 85% by 2020.

The projections suggest a decline in the number of estates liable to IHT in the short term, but a further rise in the long run if the indexation of the IHT threshold continues after 2007 at the average real rate seen since 1997.

Simon Rees, tax senior manager, PricewaterhouseCoopers added: "Soaring house prices up to mid-2004, combined with the government’s focus on IHT planning for the family home, means many homeowners are caught between a rock and a hard place."

"Married (or from December, registered civil partnership) couples worried about their IHT liability should consider holding the family home as tenants in common, rather than joint tenants, so that part of the property can be passed independently. Remember too that there's plenty of simple IHT planning to be done with general exemptions – the key thing is to start planning early."