New Residence Nil-Rate Band - What You Need to Know

The nil-rate band is currently £325,000, and married couples and civil partners may use each other's nil-rate bands, meaning the total tax-free amount married couples or civil partners  can leave on their deaths is £650,000.

Amid much fanfare, it was announced that in certain circumstances the IHT threshold would be £1m. This would be achieved not by raising the nil-rate band, but instead by introducing a new, separate inheritance tax allowance called the 'residence nil-rate band'.

The residence nil rate band will be effective from April 2017, when it will be worth £100,000. This will rise by £25,000 per year until 2020, when it will be worth a maximum of £175,000. Married couples and civil partners may use each other's residence nil-rate bands, thus arriving at the £1m figure.

The intention was, ostensibly, to ensure that people could leave their main home to their children tax free, in the majority of cases. The cynical amongst us would say that the real intention was to allow the government to cheaply fulfil a manifesto pledge by limiting the number of people who would qualify for the additional allowance. Either way, the introduction of an entirely new nil-rate band, rather than simply increasing the basic nil-rate band, has led to some complexities.

Eligibility

To be eligible for the additional IHT relief, you need to meet certain conditions:

• You must own a property.
• You must live in that property as your main residence.
• You must have children, and you must be leaving your home to your children (or other direct descendants) on your death.
• Your total estate must be valued at less than £2m. If your estate is worth more than £2m then the relief tapers, so that for estates worth more than £2,350,000, the relief will not apply at all.

Downsizing

Predictably, given the need to limit eligibility to the relief, there are areas of concern with the new rules. For example, it can immediately be seen that people who don't have children, or who don't own property, will not benefit from the new rules. But what about people who have had to sell their home to fund long-term residential care? What about people who may have downsized to a smaller, less valuable property?

It is questions such as these which have prompted the government to propose amendments to the rules.  It is now proposed that if you:

There are however still a number of concerns with the new allowance:

• have downsized to a less valuable residence and leave the new residence, together with assets of equivalent value to the previous residence, to your descendants
• sell your only residence and leave the sale proceeds, or other assets of equivalent value, to your descendants
• otherwise cease to own your only residence, and leave other assets of equivalent value to your descendants

Then your estate will still be able to benefit from the residence nil rate band in full.

Whilst the downsizing rules do add another layer of complexity to the residence nil-rate band, they are a welcome response to legitimate concerns that in their absence, people would be incentivised to retain property rather than sell it, and people who are forced to sell would be penalised.

Other Concerns

• The residence nil-rate band is lost if you leave your estate to a trust, instead of directly to your descendants. Some trusts are exempt from this rule. However parents who leave their estates to their children at a later age than 25, and who die before the children reach that age, would lose the residence nil rate band. If, as is very common, you have left your estate to a discretionary trust, then you will not benefit from the new residence nil-rate band.
   
• The new allowance does not apply to lifetime gifts; so if you give your residence to your children during your lifetime, you lose the allowance.
   
• The new allowance does however apply to lifetime gifts that were subject to a reservation of benefit.
   
• If you have more than one home, you can nominate the property you would like to apply the residence nil-rate band to. This in itself is not a concern; however, clients who have more than one property and who made specific gifts of property in their wills may need to review them to ensure the distribution of their estate is still as desired.
   
• For couples with a combined estate of between £2m and £4m, careful planning is needed to ensure that the residence nil rate band is not entirely lost.

Summary

Inheritance tax is, for most people, the largest single tax bill they (or rather, their estate) will ever have to pay. It is therefore unfortunate that in an attempt to take more people out of the IHT net, the government has created a complex new set of rules which require careful planning to avoid falling foul of.

Ultimately the best advice is that if your estate is worth more than £325,000 (or £650,000 as a married couple or civil partners) then it is still important to seek proper advice to ensure your children's inheritance is maximised, and to regularly review that advice.

For more information, please contact Iain Aitken on 020 7665 0834.