Inheritance Tax and the Family Home

Much was made in the aftermath of the Summer Budget of the so called “increase in the Inheritance Tax (IHT) threshold to £1m” for married couples. Taking this on face value you could be forgiven for thinking that this sounded very generous and surprisingly straightforward to implement. The reality is very different and the devil is very much in the detail.

As a recap of the basic current rules, each individual is entitled to an IHT Nil Rate Band (NRB) on their death of £325,000 (and it has been confirmed by the new legislation that this will be frozen at this level until April 2021).  If the value of one’s estate on their death is less than that sum, no IHT is payable.  If married couples have their wills written so that all their assets on death are passed to the surviving spouse then on the death of the second spouse they can benefit from their widow/widower’s NRB as well, meaning that the value of their estate would have to be more than £650,000 before any IHT charge is triggered.

The changes announced in the Summer Budget introduce a new Residential Nil Rate Band (RNRB) which gives an additional NRB in respect of a residential property which is left on death to direct descendants.  This will eventually be set at a level of £175,000 per individual.

The combination of the NRB and the RNRB will therefore enable an individual to claim relief of up to £5000,000 (£325,000 plus £175,000), which in turn means that a couple may be entitled to relief of £1m, and this is the figure that hit the headlines.

Before we get too carried away assuming that’s the end of the story, it should be noted that the RNRB is being ‘phased in’ over four years starting at £100,000 for deaths on or after 6 April 2017.  The maximum amount will increase as follows:

£100,000 for 2017/18

£125,000 for 2018/19

£150,000 for 2019/20

£175,000 for 2020/21 onwards.

There are similar rules to those already in force permitting an unused NRB to be carried forward and used on the death of a surviving spouse/civil partner in the case of deaths before 6 April 2017.  The amount will be limited by reference to the value of the residence being closely inherited.

The aim of the new rules is to make it easier for homeowners to pass on the family home to direct descendants without triggering IHT liabilities.  The RNRB will therefore only be available where a residence is left to one or more direct descendants e.g. children (including step-children, adopted children or foster children), grandchildren and spouses/civil partners of those children etc.  The property does not necessarily have to be the property in which the individual lives when they die but it must have been occupied by them as their ‘residence’ at some point and included in their estate at death.  If more than one property meets these criteria, the personal representatives of the deceased will be able to choose to which property the RNRB should be applied.  The RNRB will not be available

for buy-to-let properties or holiday homes etc. if the individual had never lived in these as his/her residence.

It should also be noted that, for properties which exceed the value of the RNRB, any unused NRB will still be available to cover the excess.

Another caveat is that for estates valued at over £2m (after deducting any liabilities but before reliefs and exemptions), the RNRB will be gradually reduced by £1 for every £2 that the value of the estate exceeds £2m.  It may be possible, with careful planning, to avoid this restriction.

Consider for example if on David’s death he leaves his entire estate (worth £1.2m) to his wife Victoria.  Included in his estate is a half share in the family home (half share valued at £500,000).  When Victoria dies in 2021 the estate is then worth £2.7m so no advantage can be taken of the RNRB (including that which was unused by David).

However if David had left his share in the property to his children when he dies, the total nil rate band available to him (being NRB of £325,000 plus RNRB of £175,000) would prevent a tax charge.

This means that when drafting your will in the future it may no longer be safe to assume that if everything is left to a surviving spouse there is no loss of NRB.  It may be wise to review existing wills in the light of the proposed changes.

Whilst we all welcome an increase in inheritance tax relief, it is a shame that simpler measures couldn’t be used.  There will be individuals who won’t benefit at all, including taxpayers with no children or those who rent a property and have chosen to invest their money elsewhere such as an investment portfolio or let properties.

One of the concerns was that this new relief might discourage individuals from downsizing their residence in later life.  There will be provisions introduced to deal with downsizing (including the situation where the property is sold on moving into a care home).

In basic terms it is planned that, where an individual downsizes or ceases to own a residence on or after 8 July 2015 (the date of the budget) that part of the RNRB which might otherwise be lost will still be available provided that the smaller residence (or other assets of an equivalent value) are passed to direct descendants.  The final details of how this will work are yet to be announced, and there has been a consultation over the summer.  We can expect to learn more in the Autumn Statement at the end of November.

The above is for general guidance only and no action should be taken without obtaining specific advice