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Back in 2010 the government expressed its intention to increase the inheritance tax threshold to £1million. However, to date the nil rate band has remained frozen. After the last election the government instead decided to introduce a "main residence nil rate band".
Although this does not quite fulfil the original intention, the outcome is that by 2021 a married couple may be able to claim a total inheritance tax allowance of £1million. However, the rules are not straightforward and not everyone will be able to benefit from this new allowance.
What are the current rules on inheritance tax?
Inheritance tax is charged at the rate of 40% on the value of the deceased's assets in excess of the nil rate band. The nil rate band is currently £325,000 and will remain at this level until at least the end of the tax year 2020 to 2021.
What is changing?
From 6 April 2017 an additional "main residence nil rate band" will become available so that less inheritance tax may be paid when a residential property that had been the deceased's residence at some point, is left on death to a direct descendant.
The additional nil rate band will be phased in as follows:
From 2020/21 this will remain at £175,000 and will then increase with the Consumer Price Index.
When will the residence nil rate band apply?
The residence nil rate band will apply when:
- The deceased died on or after 6 April 2017, and
- They left their home to direct descendants, and
- They left an estate worth less than £2million (the availability of the residence nil rate band is tapered down by £1 for every £2 that the estate exceeds £2million).
Direct descendants include children (including step children, adopted children or foster children) or grandchildren and the spouse or civil partner of a direct descendant or surviving spouse or civil partner if they have not remarried or formed another civil partnership.
The allowances are the maximum allowances available.
What if the deceased owned more than one property?
The allowance is limited to one residential property and cannot be applied over various properties. Where there is more than one residential property in the estate the executors can nominate which one should qualify.
The residential property must have been occupied by the deceased as a residence at some point in time but does not have to have been their main residence.
What if someone wants to downsize?
The additional "main residence nil rate band" will also be available for individuals who downsize or sell their home after and pass assets of an equivalent value onto direct descendants on death, although evidence of the sale of the property will be required.
What about Trusts?
The residence nil rate band will only be available for certain types of trusts for qualifying beneficiaries.
For example, a life interest for a qualifying beneficiary would be sufficient, as would a disabled person's interest trust, 18-25 trust or trust for bereaved minors.
A Will that provides for the estate to pass into a discretionary trust (even if the only potential beneficiaries are direct descendants) would not qualify for the relief. However, if the qualifying residential property passes into a discretionary trust it is possible for the trustees to make an appointment of the property to direct descendants to ensure the availability of the main residence nil rate band.
Can the residence nil rate band be transferred?
As with the existing nil rate band, any unused additional nil rate band can be transferred to a surviving spouse or civil partner. Even if one partner dies before the introduction of the residence nil rate band 6 April 2017 the Executors of the surviving partner can claim the unused allowance for the benefit of the survivor's estate.
Can the allowance be used for passing on a buy-to-let property?
No. The new allowance will be limited to one residential property that was occupied by the deceased.
What are the estate planning opportunities?
Some points to bear in mind:
- If a client's estate is worth more than £2million they should see whether it is possible to arrange their affairs so that the residence nil rate band can be claimed.
- If a couple's combined assets exceed £2million then they should seek advice to see if their wills can be updated to avoid any "bunching" effect on the second death - for example they could revise their wills so that part of the estate of the first to die is inherited by their children.
- The value of the estate for the purposes of the availability of the relief (i.e. the £2million threshold) does not include failed potentially exempt transfers - therefore it could be beneficial to make lifetime gifts of other assets.
- The new allowance only applies to transfers of property on death - so gifts of property before death to direct descendants will not qualify.
- It remains possible for beneficiaries to enter into a deed of variation after death to ensure the qualifying residential property passes to direct descendants.
Good news then?
Whilst this is good news for those wishing to pass the value of their family home onto their children or grandchildren, the nil rate band itself is now frozen until at least April 2021. This means that for the unmarried, and for those who leave no children or grandchildren, the inheritance tax nil rate band will remain the same, so more families may be drawn into the inheritance tax net.
To ensure the tax saving effect of the residence nil rate band is maximised, we strongly recommend that clients review their will (or make a will if they do not have one).
The conditions for claiming the residence nil rate band are complicated, so professional advice should be sought to ensure that the benefit of this enhanced nil rate band can be enjoyed.