When I joined the profession back in the early 1990s, Inheritance Tax (IHT) was often a bit of an after-thought – a tax that affected very few people other than the “super rich”, who themselves had become quite adept at side stepping the worst effects through a range of well-established family tax planning routines.
Since then, however, IHT has become increasingly significant. This is due to the rise in property prices, which has vastly outstripped the rate of growth of the IHT nil rate band, the amount of an individual’s estate that is exempted from IHT. That amount is currently £325,000 and has been fixed at that level since 2009. We already know that it will not rise until 2021 at the earliest.
To demonstrate the profound nature of the change over that period, in 1997 the nil rate band stood at £200,000 whilst the average house price in England was £57,000. Today, that average figure is £238,000 – in the South East of England the figure £373,000, in Greater London £616,000!
Those numbers have meant that even married couples – who can usually double up their nil rate band to £650,000 – in this part of the world can expect at some point to have to give some thought to their potential IHT exposure.
The government has for some years wanted to make it easier for the family home to pass down the generations without IHT. It was always thought that the obvious way to do this, without wholesale reform of IHT itself, was simply to increase the nil rate band or introduce some form of main residence relief along the lines of the well-established similar capital gains tax relief.
Unfortunately, whilst the government has acted to assist families with the issue of the family home, it has chosen to do so in a way that is far more complex than anticipated with the introduction of the Residence Nil Rate Band (RNRB), which applies to deaths after 5 April 2017. The RNRB will provide an additional nil rate band when an individual passes their main residence to their direct descendants on death.
The rate of Residence Nil Rate Band has been set as follows:
From then on the Residence Nil Rate Band will be increased annually for inflation.
However the amount of RNRB will be reduced by £1 for every £2 by which the deceased’s estate on death exceeds £2 million (also to be increased for inflation from 2021). This £2 million limit will take into account the value of assets that aren’t taxed because they qualify for other IHT reliefs such as business property relief. By 2021 this means that estates exceeding £2.35 million will get no RNRB (except where a surviving spouse has inherited unused relief in which case the figure is £2.7 million).
The complexity of the new RNRB means that it will not apply to all circumstances and there are a number of pitfalls for the unwary who could as a result lose the RNRB and face an unexpected extra IHT bill for their families to pay.
So in what circumstances will the Residence Nil Rate Band apply? It will apply where a “qualifying residential interest” is “closely inherited”. Those terms need to be considered carefully in the context of the individual.
A “qualifying residential interest” is a residential property which at some point during the deceased’s period of ownership was occupied by them as a residence. This is very different – and more generous in many ways – from the capital gains tax and 3% stamp duty land tax surcharge definitions which require the property to have been the “main residence” for specific periods of time. As a result, a property that has previously been lived in, but is now a buy-to-let can be a “qualifying residential interest”.
“Closely inherited” requires the property to be passed to specific types of beneficiaries specifically children, grandchildren, their spouses or widows/widowers of those children/grandchildren provided they have not remarried at the date of death. This means that anyone who doesn’t have children or grandchildren cannot benefit from the RNRB.
The RNRB will however apply where the estate sells the property and distributes the proceeds to qualifying beneficiaries rather than simply passing the property to them.
The new legislation also takes into account the fact that many elderly people choose to downsize their homes. Where an individual has sold their home after 8 July 2015 (the date the legislation was announced), does not own a “qualifying residential interest” at death, but did so previously or the qualifying residence at death is at a lower value than a former qualifying residence, the RNRB will be available at a higher value than what is actually contained in the estate if needs be.
There are a few other pitfalls to watch out for:
- RNRB is only available at death and NOT for lifetime gifts even when the donor doesn’t survive seven years.
- It is quite common for estates to put property into trust for beneficiaries. RNRB is only available to certain types of trust (where children or grandchildren are beneficiaries of that trust) and crucially NOT where the property is placed into the most common type – a discretionary trust.
Of course I have only scratched the surface here, both of the new Residence Nil Rate Band and IHT more generally. If you want specific advice please feel free to contact me at firstname.lastname@example.org.
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