Inheritance tax Residence Nil Rate Band explained

Did you know, you can pass up to £1 million on to your children free of inheritance tax? No more inheritance tax on family homes. Our helpful series of articles on tax will keep you informed with what you need to know.

6 April 2020 marked the first time that former Chancellor George Osborne’s 2015 ‘£1 million inheritance tax (IHT) free’ statement became fact. The residence IHT nil rate band (RNRB) originally came into effect for deaths on or after 6 April 2017 at a level of £100,000 and has been increased every tax year since by an additional £25,000 reaching £175,000 for the 2020/21 tax year. As both the IHT nil rate band and the residence nil rate band have now been frozen until 5 April 2026 the £1 million threshold will be with us for some time yet. What does the IHT RNRB mean for you now?

The ability to pass up to £1 million of your estate IHT-free will be available in certain circumstances. But establishing the position could be very complicated and will depend on a number of factors including your marital status, whether or not you have children, the value of your family home, the value of your total estate on death, who inherits the family home and, ultimately (and rather more difficult to predict), the time of your demise.

What is the Residence Nil Rate Band (RNRB)?

The RNRB acts as a top-up to the current IHT NRB (2021/22 – £325,000) and works in a similar manner by reducing the value of your estate that is subject to IHT at the full rate of 40%. It is potentially available for deaths on or after 6 April 2017 where, in general terms, an interest in the family home is left under your will to your children, grandchildren or other lineal descendants. The RNRB is set-off against the value of your estate ahead of the NRB.

How will you qualify for the RNRB?

Your estate at the time of your death must include an interest in a dwelling-house which you have occupied or intended to occupy as your home during your lifetime (e.g. the family home). The value of an interest in, for example, a buy-to-let property will not qualify. If you own an interest in more than one qualifying property then your executors will be able to nominate the property which should benefit from the RNRB. It will not be possible for the RNRB to be spread over the value of more than one property.

In order to qualify for the RNRB the interest in the family home must be ‘closely inherited’ by your direct lineal descendants i.e. your children (including step-children, adopted children, foster children), grandchildren, etc. Interests in the family home left to spouses or civil partners of direct lineal descendants will also potentially qualify for the RNRB. The RNRB is not, however, available to those who do not have children i.e. an uncle looking to leave his family home to his nephews and nieces.

The RNRB may still be available where an interest in the family home becomes held in trust under your will, but this will depend in practice on the type of trust and the beneficiaries of the trust satisfying the closely inherited test. An interest in the family home left, for example, to a discretionary trust may not qualify for the RNRB even where the potential beneficiaries are your children.

How much RNRB will be available?

The maximum amount of RNRB on a death in the 2019/20 tax year was £150,000. This was increased to £175,000 for a death in the 2020/21 tax year and has been frozen at this level until 5 April 2026.

At its simplest, in 2021/22 where the full RNRB is in play, a married couple would not pay IHT on £325,000 + £175,000 = £500,000 x 2 spouses = £1 million where the RNRB applies.

There is, however, a tapered reduction of the RNRB where the net value of the assets held in your personal estate at the time of your death is over £2 million. In this situation the maximum available RNRB will be reduced by £1 for every £2 your net estate is valued in excess of £2 million. This means that for a death in the 2021/22 tax year (when the maximum available RNRB will be £175,000) there will be no RNRB available where your net estate is worth over £2.35 million.

The RNRB only applies to the net value of your interest in the family home. Where an interest in the family home is subject, for example, to an outstanding mortgage or equity release scheme at the time of your death this debt will require to be taken into account when calculating the level of the RNRB.

Another restriction is that  where an interest in the family home is only worth, say, £125,000 then the remaining RNRB for a death in the 2021/22 tax year of £50,000 will not be available to reduce the IHT payable at 40% on other assets in your estate.

What will happen to any unused RNRB?

Where you have a spouse or civil partner, it may be possible for any unused RNRB to be available as a ‘brought forward allowance’ and utilised on the death of the survivor of you, when calculating the IHT on the family home, as each spouse or civil partner is entitled to a RNRB.

This works in a similar manner to the usual transferable IHT NRBs. The surviving spouse or civil partner’s RNRB is increased by the proportion of the unused RNRB following the first death. This results in up to a doubling of the RNRB on the death of the surviving spouse or civil partner. The ability to transfer unused RNRB does not extend to unmarried couples with children. In these circumstances, an unmarried couple has to consider leaving their interest in the family home to their children on the first death in order to avoid the individual’s entitlement to the RNRB being lost.

Example

• Ken and Barbie are married with children. Ken and Barbie’s jointly owned estate is worth £1 million and includes a family home worth £500,000.
• Ken dies in December 2016 and leaves everything to Barbie. The value of Ken’s personal estate is below the taper threshold of £2 million and therefore 100% of his RNRB will be available on Barbie’s death.
• 100% of Ken’s IHT NRB will also be available since he left everything to Barbie and this will qualify under the IHT inter-spouse transfer exemption. There will therefore also be £650,000 (2 x £325,000) of NRB available on Barbie’s death.
• Barbie intends to leave their £1 million joint estate to their children on her death.

The IHT position on Barbie’s death will depend upon in which tax year she dies:

The £1 million taxed at 0% which was promised only ultimately becomes potentially available on the death of a surviving spouse or civil partner on or after 6 April 2020, and requires ownership of a house valued at £350,000 at least.

What happens when the family home is sold before I die?

Individuals who downsize from their family homes may still benefit from the RNRB. The RNRB will, however, only potentially continue to be available in these circumstances if they dispose of an interest in the family home on or after 8 July 2015 and either:

• Replaced it with a family home of lesser value; or
• Do not replace it, but still hold assets of an equivalent value in their estate which are left to their children or direct lineal descendants.

The aim of this concession is to prevent older couples feeling forced to hang on to their family home purely to save IHT by virtue of the top up RNRB, and also so that individuals who move into care are not penalised.

What does the RNRB mean for you in practice?

The RNRB should, in theory, enable those who own an interest in their family home to pass on a larger part of their estates to their children IHT-free. An unmarried or divorced person could now leave up to £500,000 of assets (including an interest in the family home worth at least £175,000) without triggering an IHT liability. For a married couple or civil partners the IHT-free figure becomes £1 million (including a family home worth at least £350,000).

The biggest winners are married couples or civil partners who are homeowners who leave all their assets to each other and ultimately to their children under their wills. This is the strategy that is adopted by the vast majority of married couples with children. No further action should in theory require to be taken in these circumstances to maximise the availability of the RNRB, subject to being aware of the tapered reduction in the RNRB where your own personal estate is worth over £2 million. It may be possible to minimise the impact of the taper rules through lifetime planning to reduce the value of your personal estate on death.

On the other hand, the closely inherited test means that only those with children or other direct lineal descendants will potentially benefit from the RNRB. The freezing of the IHT NRB at its current level of £325,000 until the start of the 2026/27 tax year will be an even bitterer pill to swallow for individuals and couples who will not qualify for the RNRB as a result of not having any children of their own through choice, medical reasons or otherwise.

Further information

The RNRB unfortunately adds an additional layer of complexity to the existing IHT rules, which could have been prevented by simply increasing the current IHT NRB. An increase in the IHT NRB would have ensured that everyone would potentially benefit rather than only individuals with both an interest in a family home and children and other direct lineal descendants being able to benefit from the RNRB. The Office of Tax Simplification in their 2019 IHT Review highlighted the complexity of the RNRB, but felt it was too soon since its introduction to be able to recommend for it to be reformed or removed.

Individuals looking to maximise the benefits of the RNRB should be considering the terms of their wills and also whether or not they should be undertaking any lifetime estate planning to help minimise the IHT exposure.

Our Private Client Services offers a full portfolio of advisory services in tax planning, asset protection and family advice. It is a full-service solution to meet individual and family needs.

For further tax planning advice, please contact Martin Campbell, Alison Pryde or Alasdair Johnstone, or speak to your usual Anderson Strathern contact. We would strongly recommend that you seek specialist advice tailored to your own circumstances before taking any action.

You may be interested in our other tax insight articles and in our Insight Hub.

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