Parents will be able to leave homes worth up to £1m to their children free from inheritance tax, according to leaked Tory plans.
The measure is designed to benefit middle class homeowners in the south whose "modest" homes have risen significantly in value and therefore been dragged into the inheritance tax threshold.
The plans, which have been drawn up for the Treasury, would also see the inheritance tax bill on homes worth up to £2m cut by £140,000.
They will not be in the Budget on Wednesday, but are expected to form a centrepiece of the Conservative manifesto.
The move would cost nearly £1bn and would mean that by 2019/20 20,000 fewer estates would be caught by the 40% tax, according to the Treasury documents which have been seen by The Guardian newspaper.
The papers, marked "sensitive", detail how Mr Osborne's plans would see a further £350,000 made tax-free on top of the £650,000 that can already be passed on to family free of tax.
Drawn up under the guidance of Treasury financial secretary David Gauke, the document said: "You have indicated a desire to reduce the burden of inheritance tax.
"Having considered the cost of a substantial increase in the existing nil-rate band you and the Chancellor have indicated you would like instead to introduce a more targeted measure to allow the family home to be passed to the children of deceased without it leading to an inheritance tax liability.
"This reflects the concern raised by the public about rising house prices increasingly leading to estates with a modest house particularly in London and the south-east paying inheritance tax."
It is believed Mr Osborne had submitted the plan ahead of the Autumn Statement, but they were rejected by the Liberal Democrats.
Speaking to Sky News, Lib Dem Business Secretary Vince Cable said raising inheritance tax to £1m was "not a very high priority".
He said: "Given the overall position of the economy where we have still got a big budget deficit and people are still struggling if we are going to be cutting people's taxes we should start with people at the bottom rather than starting from the top and work down."
David Cameron and the Tories have long made it clear they want to make changes to inheritance tax, but as part of the coalition agreement they committed to making income tax cuts a priority.
Speaking on Tuesday Mr Cameron denied the Lib Dems had blocked the plan and said: "That's not the case. This isn't a Budget leak. It's not something in the Budget and you'll see the Budget tomorrow."
The Liberal Democrats have been key in pushing for the level at which people start paying tax on their income to be significantly increased. Mr Osborne is tipped to announce it will be increased to £11,000 in Wednesday's Budget.
Ahead of the Budget the Coalition has announced there will be an increase in the minimum wage by 20p to £6.70 an hour this October, helping 1.4m low-paid people.
A Treasury spokeswoman said they had no comment on the report.
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