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Understanding the Residential Nil Rate Band

Understanding the Residential Nil Rate Band


Expert view

In the Summer Budget of 2015 George Osborne announced this additional nil rate band.

He said “You can pass up to £1m on to your children free from inheritance tax. No more inheritance tax on the family home”.

This news made the headlines with little of the detail of how the RNRB would work.

Many can therefore be forgiven for thinking that if their estate is worth less than £1m they will not be paying inheritance tax and that the family home is exempt from inheritance tax. Both of these assumptions are wrong.

Whilst this new measure looks like it fulfils the promise of a £1m nil rate band, it only fulfils it for some individuals and others do not even benefit at all.

The Nil Rate Band (NRB) & Residence Nil Rate Band (RNRB)

Until the announcement of this additional RNRB, there was only one nil rate band (currently £325,000, frozen until 2021) and inheritance tax (IHT) was chargeable at 40% of a net estate (assets less liabilities, reliefs and exemptions that apply) above this amount after taking into account any lifetime transfers that have become chargeable.

Since 9 October 2007, for deaths after that date, it has been possible to transfer an unused NRB to the estate of a surviving spouse. This would potentially double the NRB available on the death of a surviving spouse to £650,000, where the first spouse to die left everything to the survivor (or other exempt beneficiaries). 

For deaths after 6 April 2017, there is now a new RNRB for estates that include a residential property that is passed on to one or more lineal descendants on death.

Firstly it is important to understand what a “residential property” means for this purpose. It is any property that has at any time been a residence for the deceased. It could therefore be a holiday home that the deceased spent a proportion of the year in or the “family home”. It can never be a buy to let property in which the deceased has never lived. The RNRB can only apply to one property, but if there are more than one in an estate, the PRs can decide which one to apply it to.

Secondly, “lineal descendants” mean children of the deceased (including step, adopted and foster children) and their lineal descendants (e.g. the deceased’s grandchildren etc.). Instantly therefore, those who do not have children are wiped out of the equation. If you do not have any children then you do not qualify.

How much is the RNRB?

In terms of the value of the RNRB, it is being phased over a few years and is not available in full for another 4 years:

£100,000 - 2017/18

£125,000 - 2018/19

£150,000 - 2019/20

£175,000 - 2020/21

After 2021 the RNRB will rise in value in line with the Consumer Prices Index. Even so, with rising house prices it is clear to see how over time this additional allowance will be eroded in certain parts of the country, at least whilst the main NRB remains frozen at £325,000.

The amount applicable in any given case is the lesser of the value of the residential property concerned, or the band currently in force.

So for example, if a Mr Smith dies in the tax year 2020/21, leaving a property, or share in a property valued at £150,000, then only £150,000 of relief is available. The extra “unused” £25,000 is not transferable to a surviving spouse, nor can it be applied to the rest of the deceased’s estate.

It is important to note that the value of the property in question is the net value, less any liabilities, such as a mortgage. Therefore in the above example, if Mr Smith also had a mortgage of £50,000, even though this might be paid off by his estate, only £100,000 of relief would be available.

Just like the main NRB this additional RNRB is transferable between spouses if it is completely unused. This transfer even applies where the first spouse died before the RNRB was implemented (so to current widow/ers), as long as the survivor dies after 6 April 2017. It doesn’t matter that the spouse who died first never owned a property. also, like the main NRB, a claim needs to be made on the death of the surviving spouse to claim the transfer of the RNRB.

Estates worth over £2m

There is bad news for those with net estates worth over a £2m (that is net of liabilities but before the deduction of application reliefs and exemptions). The RNRB is tapered by £1 for every £2 that the estate exceeds that figure. This means that for estates exceeding £2.2m in 2017/18, no RNRB will be available.

Downsizing

There was concern this relief would deter the elderly from downsizing or moving into care homes for fear of losing this tax relief. This could lead to a further shortage of housing for growing families. For this reason, provisions are included to ensure that if the deceased sold their home after 8 July 2015, and bought one of a lesser value or moved into a care home, so long as the value of the initial property is still represented in the estate, then the RNRB will continue to apply.

Summary

The RNRB is applicable to deaths after 6 April 2017 where:

• There is a property the deceased has lived in at some point;

• Is left to children or other lineal descendants. It should be noted that:

• It is applicable to only one property;

• It can be transferred between spouses if unused;

• The value of the property is the net value, less any mortgage and the relief applicable is the lesser of the value of the property concerned, or the band currently in force;

• It can be applied to the proceeds of sale if downsizing has taken place;

• The relief available is tapered for estates worth over £2m.

In short, where the survivor of a married couple (whose spouse left their entire estate to exempt beneficiaries and made no failed lifetime gifts) dies after 6 April 2020 and leaves a residential property (as defined) worth in excess of £350,000 to his/her lineal descendants, the full £1m nil rate band will be fully applicable.

The need to review wills

The RNRB will also only be applicable if gifts to lineal descendants are made in a will in the right way. For example, it is no longer possible to place the whole of your estate on discretionary trusts if you wish to qualify for the RNRB. In that scenario, although your children may be beneficiaries, they do not have an absolute right to anything, in particular not the residential property and so it is not a qualifying transfer.

Similarly, if you are leaving your residuary estate to your children and other individuals who are not your descendants, it will be necessary to:

• either make a specific gift of your residential property to your children before the gift of residue

•  make clear that the share of your residuary estate left to your children should, as far as possible include the residential property

It is therefore apparent that for those with estates that currently exceed the nil rate band of £325,000, a will review is important to ensure that any gifts made to children, do qualify for the new RNRB.

In addition, tax planning measures may need to be considered for those with estates above £2m, to ensure that they can maximise the amount of RNRB available to them.

George Osborne has managed to introduce a very complicated provision, in the guise of a very simple increase of the NRB. The emphasis on safeguarding the family home from inheritance tax seems somewhat misguided when, in my experience, the family simply wish to sell it. A straightforward increase in the nil rate band would have been far simpler to implement in terms of legislation and administration, but sadly has been deemed too expensive.

If you require further advice on this issue or other tax planning issues, please contact a member of our Trusts & Estate Planning Team on 0117 926 4121.