By April 2020, estates of up to £1 million may be able to be passed on free of inheritance tax (IHT), but getting to that point can be complicated.
The IHT nil-rate band (NRB) will remain at £325,000 until April 2021. A surviving spouse or civil partner can inherit any unused NRB to be used on their death. This potentially gives £650,000, which is IHT-exempt.
For deaths on or after 6 April 2017, there is a potential residence nil-rate band (RNRB) available. This starts at £100,000 in 2017/2018, rising to £175,000 by 2020/2021.
A surviving spouse or civil partner can also inherit any unused RNRB, even if the first death occurred before 6 April 2017. This potentially gives a further £350,000, which is IHT-exempt, making a maximum of £1,000,000.
Basic RNRB rules
Your estate will be entitled to the RNRB if:
• You die on or after 6 April 2017.
• You own at least a share of a home, or have downsized since 7 July 2015.
• Your direct descendants inherit at least a share of the home.
• The value of your estate does not exceed £2 million.
The date of death determines the maximum RNRB available.
Your home must be included in your estate, and you must have lived in it at some point. It does not need to have been your main residence, and nor is there a minimum residency period.
The value of your home is its open market value less any liabilities, such as a mortgage. If only a share of the house is left to direct descendants, then only that proportion is used when calculating the RNRB available. If you have downsized or otherwise disposed of your home after 7 July 2015 , then your estate may also be eligible for a downsizing addition to your RNRB.
Another condition is that your home must be inherited through legal means as a result of death, for example, via a will or intestacy. This includes the home being sold as part of the estate administration with the proceeds being passed to a direct descendant.
Your home does not have to be mentioned in the will and could be passed as part of the residue. If your home is part of the general estate, then the RNRB can only be used for the proportion of your home received by direct descendants.
If your home is instead specifically left to direct descendants then up to the full value of the RNRB will be available, potentially to the advantage of all beneficiaries, including those who are not a direct descendant.
If your home is only conditionally inherited, for example, if it is subject to the beneficiary reaching the age of 21, then the RNRB does not apply. If your home is held in trust before your death, it will only qualify for the RNRB if it becomes part of your estate for IHT purpose on your death.
Direct descendant specifics
For the purpose of the RNRB, your direct descendants are:
• Your child, grandchild or other lineal descendant.
• The spouse or civil partner of a lineal descendant, including a widow, widower or surviving civil partner.
Your child includes:
• Your stepchild, if the child’s parent is or was your spouse or civil partner.
• Your adopted child.
• A child you have fostered.
• A child for whom you were appointed as a guardian or special guardian when they were under 18.
Any direct descendant of your child is also your direct descendant.
Larger estates
Your RNRB is reduced by £1 for every £2 that your estate exceeds £2 million. For example, dying in 2017/2018 with an estate worth £2.1 million would reduce the £100,000 RNRB to £50,000, so this £100,000 is effectively subject to 60 per cent IHT.
Your estate value is total assets minus total liabilities. You do not subtract exemptions, for instance spousal exemption, or reliefs, for example business property relief.
Nor do you add any gifts made in the previous seven years.
Downsizing addition
If your estate does not contain a home that uses up the RNRB then a downsizing addition may apply if:
• You downsized or ceased to own a home after 7 July 2015;
• The home would have qualified for the RNRB if you had kept it until death;
• At least some of the estate is inherited by your direct descendants.
If the value of your home on death uses the maximum RNRB, then there is no loss of RNRB and therefore no downsizing addition.
There are other situations where there will be no downsizing addition available. Therefore, the downsizing addition will usually be the lower of:
• The RNRB lost due to the disposal.
• The value of your other assets inherited by your direct descendants.
The downsizing addition cannot exceed the maximum RNRB, which would have applied if you had kept your home until death. If there is more than one disposal your personal representatives choose which is taken into account.
Calculating the addition
First calculate the value of the home as a percentage of the maximum RNRB at the date of disposal, capped at 100 per cent. The maximum RNRB is £100,000 for a pre-6 April 2017 disposal. Then calculate the value of any home in the estate on death as a percentage of the RNRB available on death, including transferred RNRB. If there is no home in the estate this percentage is zero.
Finally, deduct the first percentage from the second percentage to give the percentage to be applied to the RNRB at the date of death to give the maximum downsizing addition. The RNRB could save significant amounts of IHT depending on the exact will provisions. Post death, a deed of variation could be considered. For those advising on IHT, an understanding of the RNRB will prove crucial.
This article is a relatively brief summary of complex provisions, based on HMRC guidance and legislation as at 1 December 2016.
Phil Warner is head of technical at Hargreaves Lansdown
