The introduction of the “residence nil rate band” with effect from 6 April 2017 is arguably the most significant development in the inheritance tax legislation since 2007 when the then Labour Government permitted the “standard” nil rate band to be transferred to a surviving spouse or civil partner.
The standard nil rate band is currently £325,000 and the Government has announced that it will remain at this level until 6 April 2021 at the earliest.
Why has it been introduced?
The residence nil rate band has been introduced for deaths on or after 6 April 2017 where an interest in a main residence passes to direct descendants. The amount of relief is being phased in over four years; starting at £100,000 in the 2017/18 tax year and rising to £175,000 in the 2020/21 tax year. For married couples and civil partners the relief is effectively doubled as each individual has a standard nil rate band and each will also potentially benefit from the residence nil rate band.
For these purposes the “main residence” does not have to be the deceased’s home at the date of death, however, he or she must have lived in the property as his or her residence at some point. An investment property in which the deceased never lived would not qualify as a residence for these purposes.
How direct descendants are affected
In order for the residence nil rate band to be available the residence must pass in the will to “direct descendants”.
The term “direct descendants” includes a child of the deceased (included a step-child, adopted child and a foster child) as well as other lineal descendants e.g. grandchildren and great-grandchildren.
Where the residence is left in the will to the trustees of a trust , the nature of the trust will determine whether the residence nil rate band will be available. By way of example, where a parent leaves the residence to an interest in possession trust of which his or her child is the life tenant, relief will be available, By contrast, where the residence is left to a discretionary trust, relief will not be available – even if the deceased’s child is a potential beneficiary of the trust.
Qualifying for the residence nil rate band and restrictions for £2m+ estates
Where a person dies before 6 April 2017, their estate will not qualify for the residence nil rate band.
A surviving spouse may be entitled to an increase in the residence nil rate band if the spouse who died earlier has not used, or was not entitled to use, their full residence nil rate band. The calculations involved are potentially complex but the increase will often result in a doubling of the residence nil rate band for the surviving spouse.
Where the value of a deceased’s estate exceeds £2 million the residence nil rate band is tapered away. For every £2 that the value of the net estate exceeds the £2m threshold, £1 of residence nil rate band will be lost. Given this, for deaths in the 2017/18 tax year, where the residence nil rate band will be £100,000, no residence nil rate band will be available where the estate is valued at over £2.2m (or £2.4m where the unused residence nil rate band has passed to a surviving spouse or civil partner). For deaths on or after 6 April 2020, the taper threshold will apply to an estate valued at over £2.35m (or £2.7m where the unused residence nil rate band has passed to a surviving spouse or civil partner). In ascertaining the value of an estate to determine whether tapering applies it is vital to note that it is the value of the deceased’s estate before any special reliefs such as Business Property Relief and Agricultural Property Relief that is taken into account.
“Downsizing” or ceasing to own a residence
The residence nil rate band may also be available where the deceased has “downsized” to a smaller residence or has ceased to own a residence on or after 8 July 2015 (perhaps on moving into a care home) providing assets of an equivalent value, up to the value of the residence nil rate band, are passed on death to direct descendants.
Implications and inheritance tax planning actions required
As will be appreciated from the above, many married couples and civil partners will have inheritance tax nil rate bands of £850,000 currently potentially available to them, rising to £1 million by 6 April 2020. The residence nil rate band alone could save their descendants inheritance tax of as much as £140,000 (£350,000 @ 40%) in the 2020/21 tax year.
Given this it is all the more important that individuals with substantial estates take advice on their potential inheritance tax liability position and how this can be mitigated. Wills should be reviewed to ensure that they are inheritance tax efficient, do not crystallise an inheritance tax liability on the first death and do not preclude the availability of the new residence nil rate band. An individual should regularly review the value of his or her estate given that the residence nil rate band can be tapered to nil in certain circumstances. Lifetime gifts- either absolute gifts or gifts into trust - are likely to continue to play a key role in inheritance tax planning given it is the value of the estate on death that determines the extent of the residence nil rate band available.
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