The waiting is almost over! The new Residence Nil Rate Band (RNRB) for Inheritance Tax (IHT) that the Government announced in summer 2015 will come into play from 6 April 2017.
The RNRB will allow more people to pass on their family home to their descendants without paying IHT. It works by giving homeowners an additional IHT allowance that can be set against the value of their home when it is being passed to a “direct descendant” following their death.
The original intention seems to have been to address the disproportionate amount of IHT that is paid by estates in the south east of England, caused by higher house prices in that region. However the RNRB will also take a large number of families in Scotland outside of the reach of IHT.
This is the biggest change to the IHT laws in around a decade, so here are six things that you need to know:
- It is NOT a change to the general IHT allowance for individuals
Individuals already receive a Nil Rate Band (NRB) of £325,000. This allows them to leave up to £325,000 to their beneficiaries when they die without paying any IHT. Any estate left above that level is taxed at a rate of 40%. Inheritance passing from one spouse or civil partner to the other is exempt from IHT – known as “the spouse exemption” – and if one spouse does not use all of their NRB when they die, then the unused portion can be used by the other spouse on their death – which can effectively double-up the available NRB to £650,000 by the time of the second death.
The NRB has not been changed since 2009/10, and it will remain frozen at that level until at least 2021.
- It is NOT an exemption from IHT for houses worth up to £1M, however…
The figure of £1M is significant here, but not for that reason. Rather, providing certain conditions are met, the RNRB will give estates a further allowance to set against the value of the deceased’s family home. The new allowance will be worth £100,000 in 2016/17, growing each year until reaching £175,000 in 2020/21. Any RNRB that is not used when one spouse or civil partner dies can be brought forward to the second person’s estate when they die. Accordingly, once the full £175,000 allowance is in place, spouses or civil partners will potentially receive an aggregate £1M in IHT allowance to set against their combined estate (i.e. £325,000 + £325,000 + £175,000 + £175,000 = £1M). The level of available RNRB will be tapered off for estates worth more than £2m.
- It cannot be used against assets other than a single “qualifying residential interest”
The RNRB can only be used against one property. That property must have been used as a residence by the deceased person, though it does not have to be their main or current residence. Accordingly, the RNRB could be used to cover the value of second home, but not an investment property that the deceased never lived in. Where more than one property could qualify, the executors of the estate can choose which one to apply the RNRB against – and naturally they would likely choose the more valuable property.
If the property is worth less than the available RNRB, then the ‘excess’ allowance will be lost and cannot be used against other assets such as cash, investments or other properties. That means, for a married couple with an estate of up to £1M, it will still be possible to pay IHT: it all depends on the makeup of the estate.
If Mr & Mrs A have a house worth £400,000 and cash of £600,000, then they would avoid paying IHT, as they would be able to use the full amount of the RNRB. Whereas if Mr & Mrs B have a house worth £200,000 and cash of £800,000, then they would not be able to use their full RNRB, and their estates could have to pay £60,000 in IHT.
- It will only be available where passing the property to “direct descendants”
This will include children and grandchildren etc., and also adopted children, stepchildren and foster children. The spouses or civil partners of those people would also qualify. Property passing to other relatives such as nieces or nephews would not receive benefit from the RNRB. There is also the potential for losing the RNRB where property is passing into certain kinds of trusts, even if those trusts are actually for the benefit of “direct descendants”, as the property is not passing “directly” to them.
- It can sometimes help even if the deceased did not own a share in the family home
When you are talking about transferring the first spouse’s unused RNRB over to the estate of the second spouse, you would think that the first spouse would actually need to have owned a share of the house at the time that they died – otherwise they would not have owned a “residence”, and so seemingly would not have been able to benefit from the RNRB.
Curiously, that is not the case. Even if the first spouse had never owned a house in their life, they will still be considered as having not “used” their RNRB, which means that the second spouse, who was the one who perhaps owned the home, will still be able to benefit from the unused RNRB at the time of their death – allowing them still to reach the theoretical £1M allowance as outlined above.
- The rules do allow for downsizing
Even if you had sold your property before your death, whether to go into a smaller property or into sheltered housing or nursing care, the RNRB will still be available to give relief against the full value of the property as long as assets of an equivalent value are passed to “direct descendants”. The downsizing provisions will only apply if the house was sold on or after 8 July 2015.
This is likely to be complex to administer, but the policy reason is clear enough: during times of housing shortages, the Government does not want older people holding on to large houses just for fear of losing tax benefit.
IHT has long been an area where there is a lot of scope for productive planning to be done. The new allowance will give comfort to a great many families, but it is not a cure-all: some people will not benefit from the RNRB at all, and so will need to take other measures to reduce their exposure to IHT, while others will need to take careful steps to ensure that they maximise the benefit from RNRB. The most effective IHT planning tends to be a combination of different approaches – so the existing methods of tax planning should not be forgotten about.
The Trusts, Tax and Care team at Blackadders are experienced in assisting individuals and families with Inheritance Tax planning, and we are ready to assist with anything from small queries to more bespoke planning packages.
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Associate Solicitor – Private Client