On 6 April 2020, the residence nil rate band increased to £175,000 marking the culmination of the Conservative Party’s 2015 manifesto pledge to remove a family home worth up to £1 million from the scope of inheritance tax by the time the next election was due to take place in May 2020. Devorah Ormonde, a partner in the Private Client department, explains how this works in practice.
As there is no inheritance tax on transfers between spouses or civil partners, if the first to die leaves the whole of their estate to their surviving spouse or civil partner, both the main inheritance tax allowance of £325,000 and the residence nil rate band now totalling £175,000 can be transferred for use on the death of the survivor. This potentially enables the survivor to leave assets totalling £1 million to their children before inheritance tax would be charged on any excess at 40%.
However, there are various conditions attached to the residence nil rate band. Consequently, many estates will not qualify for £1 million of inheritance tax allowances even where everything has been left to a surviving spouse or civil partner.
How much will be available?
The residence nil rate band can only be set against the value of a property owned by the person who has died which at some time during their ownership was their main residence. It is not necessary for the first spouse to die to have owned a property for their unused allowance to be transferred.
However, if the survivor has equity of less than £350,000 in a qualifying property, the available residence nil rate band will be capped at the value of their equity in the property.
It is only possible to use the residence nil rate band against the value of one property. If a person owns two properties which they had lived in at different times both with less than £350,000 of equity their executors can choose which to use for the residence nil rate band but cannot aggregate the two. In this situation, the maximum residence nil rate band would be the value of the equity in the property with greater equity.
The main and transferable inheritance tax allowances of £650,000 can be added to the value of the available nil rate band.
Who can benefit?
The residence nil rate band can only be claimed when a qualifying property is left to lineal descendants immediately upon death. As well as children and grandchildren this can include stepchildren, foster children and children who had been adopted out of the family but not nieces and nephews.
Although there are some types of trust which can be created in wills for the benefit of direct descendants for which the residence nil rate band could be used, if the property is left in a discretionary trust, even if the only potential beneficiaries are direct descendants this would not be sufficient to satisfy the requirement for the property to have been inherited by direct descendants immediately upon death.
Similarly, if there is a right of occupation in the property for a new partner even if this is only for a short time before the property is ultimately divided between children, the residence nil rate band would not be available.
Does the residence nil rate band apply to high value estates?
Those with larger estates may not benefit from the residence nil band. Both the first spouse or civil partner to die and the surviving spouse or civil partner would need to have total estates of less than £2 million for the full residence nil rate band to be available.
For the purposes of calculating the £2 million threshold, the value of business assets and agricultural property are included even if these will attract relief from inheritance tax at 100%.
The residence nil rate band will reduce by £1 for every £2 by which the value of the estate exceeds £2 million. There would be no residence nil rate band available at all after the effect of tapering if the estate exceeds £2.35 million or if a full transferable residence nil rate band is available then £2.7 million.
What happens if a qualifying residence is sold during the deceased’s lifetime?
The residence nil rate band may still be available if the person who has died had owned a property which would have qualified for the residence nil rate band had it still been owned at their death but which was sold on or after 8 July 2015.
This applies both where no new property has been purchased because the deceased moved into rented accommodation, into residential care or into the home of other family members and also where it was sold and a property worth less than £350,000 was purchased as a replacement.
It may be necessary to update wills to ensure that properties which would qualify for the residence nil rate band are being left to lineal descendants.
In some cases it may be possible to vary the terms of a will after a death to enable the residence nil rate band to be claimed if agreement can be reached between the beneficiaries.
Steps may also need to be taken to transfer assets between spouses and civil partners during their lifetimes to ensure that neither estate will breach the £2 million threshold. It might also be sensible to consider making lifetime gifts to reduce the value of the estate.
To obtain advice on how the residence nil rate band will apply in your situation, or to update your wills or discuss transfers of assets between spouses, please contact Devorah Ormonde or Chris O’Callaghan.