10 Dec Additional Inheritance Tax relief for residences
From April 2017 there will be an additional residence nil-rate band worth up to £175,000 per individual (£100,000 in 2017/18, £125,000 in 2018/19, £150,000 in 2019/20, and £175,000 in 2020/21), with the unused residence nil-rate band of a deceased spouse or civil partner being available to the surviving spouse.
Therefore, after April 2020 the residence nil-rate band can be worth up to £350,000 which when combined with the nil-rate band (£325,000 per person to April 2021) will mean that up to £1 million can be passed Inheritance Tax free on death.
However, the relief will have restrictions:
- There will be a tapered withdrawal of the residence nil-rate band for Estates with a net value of more than £2 million (after deducting any liabilities but before reliefs and exemptions). The residence nil-rate band is to be reduced by £1 for every £2 that the amount exceeds the £2 million taper threshold.
- The residence must pass by inheritance on death to a lineal descendant (ie children or grandchildren) or a settlement in which the lineal descendant has an “immediate post-death interest” (ie the property forms part of their estate for Inheritance Tax purposes rather than being held in settlement under the relevant property regime) or a trust for minors and other persons under the age of 25.
- The relief is only available for a dwelling house which has been the person’s residence whilst it was part of the person’s estate.
- Legislation in the draft Finance Bill 2016 (see below) will extend the benefit of the residence nil-rate band where a person downsizes or ceases to own a residence after 7 July 2015 and retains assets of equivalent value in their estate to pass on death to direct descendants. The calculation of the residence nil-rate band in these circumstances will be more complex.
It is intended that from 2021/22 the residence nil-rate band and the £2 million taper threshold will increase in line with the consumer prices index.
The tapered withdrawal of the residence nil-rate band will mean that persons with an estate slightly over the £2 million threshold will suffer an effective Inheritance Tax rate of 60% on that excess. This higher effective rate of Inheritance Tax may encourage lifetime giving to bring the value of a person’s estate down below £2 million upon death.
Although an increase in the Inheritance Tax nil-rate band is long overdue to reflect the increase in residential property prices in recent years, the mechanism by which this is to be offered is unfortunately complex. Presumably HM Treasury considers the cost of a more straightforward increase to the existing nil-rate band too great to the Exchequer.
The complexities of the new residence nil-rate band will also mean that in order to maximise the relief action may be needed to consider, for example:
- Amending Wills to ensure that the residence is passed to a direct lineal descendant, rather than a discretionary trust or a sibling, niece or nephew.
- Making lifetime gifts to reduce Estates below the £2 million threshold at which the residence nil-rate band is reduced by a tapering restriction.
The following example is based upon guidance provided in an HMRC technical note issued in September 2015, but with figures amended to illustrate the effect of the tapered withdrawal of the residence nil-rate band.
A widower gives away his home worth £400,000 to his children in May 2020 and moves into rented ‘later living’ accommodation. At the time of the gift the available residence nil-rate band (RNRB) is £350,000 (as he has inherited his wife’s RNRB). He has potentially lost the chance to use £350,000 or 100% of the available RNRB which could have applied had he not given away his home.
When he dies in February 2021, within seven years of the gift, his estate is worth £2 million and is split between his four children. As there is no qualifying residence in his estate, it cannot use RNRB directly. But the estate is eligible for additional RNRB up to the maximum 100% of the available RNRB at his death or £350,000 (as the value of his home when gifted exceeded the available RNRB at that time).
The position for the gift of the house is considered first. RNRB only applies to the assets in the estate, so it is not available in respect of the gift of the house. However, the estate can claim the full transferable nil-rate band (TNRB) of £650,000 so there is no tax to pay on the gift of £400,000. The balance of £250,000 TNRB remains available to be set against the estate.
Therefore the Inheritance Tax payable on death would be 40% of the estate of £2 million after reliefs of £350,000 RNRB and the balance of £250,000 TNRB (reduced by the gift of the residence), ie £560,000.
If the widower had not given away his home to his children, the Inheritance Tax payable on death would be 40% of the estate of £2.4 million after reliefs of £150,000 RNRB (£350,000 less £200,000 taper being excess estate of £400,000/2) and the full £650,000 TNRB, ie £640,000.
In this illustration, the widower has therefore reduced the Inheritance Tax payable on his estate by £80,000 by making a gift of his residence before death, rather than retaining his home until death.
Draft Finance Bill 2016 legislation which details the extension of the residence nil-rate band was issued on 9 December 2015 and may be amended before passing into law, probably in July 2016, so further advice should be sought before acting on the basis of the above, as the new relief only comes into effect from 6 April 2017.