You could save as much £140,000 in IHT when the family home passes to your children on death.
The new IHT Residence Nil Rate Band (RNRB) will be introduced in April 2017. It is in addition to an individual's own nil rate band of £325,000, and conditional on the main residence being passed down to direct descendants (e.g. children, grandchildren). By 2020/21 families could escape IHT on up to £1M of their wealth. Each parent will have a nil-rate band of £325,000 plus a RNRB of up to £175,000.
Here are 10 key facts you need to know to:
- understand how the new rules will operate in practice;
- avoid traps and pitfalls;
- take any action needed to retain valuable additional allowance.
1. How much will it be?
The RNRB will not be introduced until April 2017. It will be phased in over 4 years and the full £175,000 allowance will not be available until April 2020. The RNRB will start at £100,000 and will increase by £25,000 each tax year until 2020.
Maximum residence nil rate band
These are the maximum amounts. The available allowance will be reduced if the value of the property is less than this.
For example, a father dies in 2020/21 and his will gifts his 50% share in the family home to his children. If this share is valued at £140,000, the extra £35,000 of nil rate band will go unused (but may be transferred to his widow).
2. When the RNRB can be transferred?
The Residence Nil Rate Band will be transferable between spouses and civil partners on death, much like the standard nil rate band. It is the unused percentage of the RNRB from the estate of the first to die which can be claimed on the second death.
This is irrespective of when the first death occurred or whether they ownedresidential property at their death. There will always be an additional 100% RNRB unless the first spouse's estate was greater than £2M.
The RNRB is a relief against the estate as a whole and is not specifically set against the residence if the residence passes as part of the residue.
3. Tapering the residence nil rate band
If the value of your estate is more than £2M, you may not see any benefit from the extra nil rate band. The RNRB will be reduced by £1 for every £2 that your estate exceeds £2M.
This means that on its introduction, there will be no RNRB available if the deceased holds assets of more than £2.2M. This will rise to assets of £2.35M in 2021/22 when the full £175K allowance kicks in.
Reliefs such as Business Property Relief and Agricultural Property Relief are ignored when calculating the value of the estate for this purpose – this means that the value of trading company shares could push you above the threshold where you don’t get any of the RNRB despite the taxable value of your estate for IHT purposes being much lower. This is hardly fair but there are numerous instances of unfairness like this in the tax system.
4. Who can benefit?
The RNRB is only available where the main residence passes to children (including adopted, foster or step children) or linear descendants on death.
However, the rules have been extended to accommodate situations where the family home passes into the joint names of the deceased's child and their spouse.
5. What if the family home passes into trust?
The residence nil rate band will be lost where, for example, the property is placed into a discretionary will trust for the benefit of the children or grandchildren.
However, some trusts for the benefit for children and grandchildren will not result in a loss of the allowance. If the trust gives a child or grandchild an absolute interest or interest in possession in the home the RNRB can still be claimed. Other trusts such as Bereaved Minor Trusts, 18 - 25 Trusts and Disabled Persons' Trusts will also retain the additional nil rate band.
6. What about downsizing?
The family home doesn't need to be owned at death to qualify. This is of help to those who may have downsized or sold their property to move into residential care or a relative's home.
The RNRB will still be available provided that:
- The property disposed of was owned by the individual and it would have qualified for the RNRB had the individual retained it;
- The replacement property and/or assets form part of the estate and pass to descendants.
Downsizing or the disposal of the property has to take place after 8 July 2015. But there is no time limit on the period between the disposal and when death occurs (albeit that death must occur on or after 6 April 2017 when these rules first apply).
7. Multiple Residences
Only one residential property will qualify. It will be down to the personal representatives to nominate which residential property should qualify if there is more than one in the estate.
A property which was never a residence of the deceased, such as buy-to-lets, cannot be nominated.
8. Basic IHT threshold frozen
Whilst you may be getting some additional nil rate band to set against your family home, the basic IHT nil rate band will be frozen at £325,000 until the end of 2020/21 tax year.
When combined with the full RNRB of £175,000 in 2020/21 this would provide a married couple with the promised £1M nil rate band.
9. Joint tenants and the trap for large estates
Some of you could miss out on the additional nil rate band by not ensuring that your estate is shared in the most efficient way.
Many of you will hold the family home as joint tenants. On the first death, this means the house passes to the surviving owner with no IHT because of the spouse exemption. The RNRB is not used on the first death, with the surviving spouse inheriting the full unused allowance. But if the combined estate on the second death is greater than £2M then both RNRBs could be reduced or lost completely due to tapering.
Switching property ownership into tenants in common will allow each spouse to control how the property passes on death, and potentially preserve your combined entitlement to the RNRB by keeping each partner's assets below £2M. On the first death, the deceased could use their RNRB by leaving part of their share in the family home to their children. In turn, this would reduce the value of the survivor's net estate. And this could be further reduced if the deceased also gives more away up to their ordinary nil rate band of £325,000. So, in total, the survivor's estate could be reduced by up to £500,000.
10. Reviewing wills
It makes sense to keep your wills constantly under review to cater for changing circumstances. This includes ensuring legislative changes do not adversely impact upon what you would have wanted after your death. Missing out on the RNRB, by passing the family home into a discretionary trust for example, could see your executors paying as much as an extra £140,000 in inheritance tax. A deed of variation may help where property is passed to an individual. But it can be near impossible to vary a transfer into a discretionary trust which has a wide class of beneficiaries, as agreement will be needed from all possible beneficiaries.
HMRC has issued guidance about how the RNRB will apply – this includes 18 short simple case studies. Their guidance can be found here - https://www.gov.uk/guidance/inheritance-tax-residence-nil-rate-band. It seems quite wrong that something that is essentially quite simple such as allowing assets worth up to £1M to be exempt from IHT should be dealt with by legislation that is so complex.
This fact sheet is for information only. It provides an overview of the regulations currently in force and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore, no responsibility for loss occasioned by any person or refraining from action as a result of this material can be accepted by the authors or the firm.