Set to come into effect from April 2017, the new ‘residence nil-rate band’ means the majority of people may soon be able to pass on a ‘family home’ tax-free on death. Here we examine the new rules in more detail.
The current rules
Inheritance tax (IHT) is currently charged at 40% on the proportion of an individual’s ‘estate’ exceeding the IHT nil-rate band, which is set at £325,000 for 2016/17. Married couples and registered civil partners can pass any unused nil-rate band to one another on death.
An estate includes both the value of chargeable assets held at death plus the value of any chargeable lifetime gifts made within seven years of death (though there may be a discount on the 40% tax rate for certain lifetime gifts). The chargeable value of assets and gifts is the value after deducting any liabilities, reliefs and exemptions that apply.
Under changes announced by the Government, an additional nil-rate band will be introduced for each individual to enable a ‘family home’ to be passed wholly or partially tax-free on death to direct descendants such as a child or grandchild. A step-child, adopted child or fostered child is regarded as a direct descendant.
The new ‘residence nil-rate band’ (RNRB) is set to come into effect from 6 April 2017 and is in addition to an individual’s own nil-rate band. The RNRB will be set as follows:
It is then set to increase in line with the Consumer Price Index (CPI) from 2021/22 onwards.
It is worth noting that the additional band can only be used in respect of one residential property. The property does not have to be the main family home, although it must, at some point, have been a residence of the deceased.
Transfers made during your lifetime to individuals or trusts cannot generally benefit from the RNRB unless the value of the property is still included in the deceased’s estate due to it being ‘a gift with reservation’. This is where the home has been legally gifted but the donor still benefits from the property, such as living in the property rent-free.
Transfers into a trust on death cannot benefit unless a direct descendant has a specific type of interest in the trust, known as an immediate post-death interest or disabled person’s interest.
Restrictions for high value estates
There will be a tapered withdrawal of the RNRB for estates with a net value (after deducting any liabilities but before reliefs and exemptions) of more than £2 million. This will be at a withdrawal rate of £1 for every £2 over this threshold. In 2017/18, the first year of operation, this means that a person with an estate of more than £2.2 million will not benefit. By 2020/21 the limit is expected to be £2.35 million. For spouses it applies on each death estate calculation. This reduction only applies where the estate, at death, exceeds the limit. It does not include lifetime transfers within seven years of death.
It is also proposed that the RNRB will be available when a person downsizes or ceases to own a home on or after 8 July 2015 where assets of an equivalent value, up to the value of the RNRB, are passed on death to direct descendants. This could apply in a number of situations, for example, where the home has been gifted or sold prior to death.
We can help you plan to minimise the tax due on your estate – please contact us for further advice.