TaxJul 31 2018

Tax spotlight: Joint tenancy and the RNRB

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Tax spotlight: Joint tenancy and the RNRB

Before the introduction of the transferable nil-rate band (TNRB) in 2006, couples often held their main residence as tenants in common. The property could then be left to trust on first death, utilising the nil-rate band (NRB) while allowing the surviving partner to remain in residence. The residence nil-rate band (RNRB) taper means that severing joint tenancy can once again result in an inheritance tax (IHT) advantage.

We are all well-versed in how the standard NRB available to an estate is reduced by non-exempt gifts made within seven years of death.

However, to calculate the available RNRB the value of the deceased’s estate is used to determine whether it is over a £2m threshold. The available RNRB is then tapered down by £1 for every £2 over the £2m threshold.

This means there is an effective IHT rate of 60 per cent on assets falling in the window between £2m and a threshold equal to £2m plus twice the available RNRB. For example, for a single person in 2018-19 the threshold is £2.25m (£2m plus two £125,000 RNRBs). For a surviving spouse dying in 2019-20 the threshold could be up to £2.6m (£2m plus two x (two individual £150,000 allowances)). 

Box One shows how the taper can remove the RNRB on second death. 

Deathbed gifts

Any gifts within seven years are considered when calculating IHT due on the estate.

However, for the purposes of applying the RNRB taper, the estate value used is before any allowances, exemptions or reliefs – the most pertinent of which are the NRB, spousal exemption, charitable exemption, and business relief – but, crucially for this planning, lifetime gifts within seven years of death are not added to the estate value. See Box Two

In order to direct a legacy, joint tenancy must be severed in favour of tenants in common. Box Three provides a reminder on standard practices here.

In both cases the valuestill forms part of the estate when calculating the IHT position.

Severing joint tenancies opens up various tax planning opportunities. It is not possible to sever joint tenancy by will, but it may be posthumously severed using a deed of variation (see HMRC’s guidance in their Inheritance Tax Manual: IHTM35092). 

Securing the survivor’s right to reside

Once held as tenants in common, a house could then be left to an alternative beneficiary, including a trust, on first death. See Box Four.

An immediate post-death interest (IPDI) trust can provide security of residence for a surviving partner while allowing the original owner to direct the ultimate destination of the house. IPDIs are commonly used where there are children from a previous marriage. The RNRB can be used on the death of the life tenant provided the remainderment are qualifying beneficiaries of the life tenant (stepchildren and their spouses would qualify). 

However, if you are trying to keep the estate of the survivor below £2m, an IPDI will not gain any IHT advantage over a direct spousal transfer; the value of the trust will sit in the life tenant’s estate.

To avoid an IPDI the spouse must have no entitlement to occupy the property. HMRC may view there to be an interest in possession even where the intention is to create a discretionary trust (see Statement of Practice 10/79). 

As is common for estate planning, there is a trade-off between control and tax planning. Some may value the security of residency over any potential tax saving and so this first-death planning is a non-starter. 

If a discretionary trust is deemed suitable, the trustees could charge the surviving occupant a market rent for the share of the house in trust which, assuming it is an affordable and acceptable course of action, would not only demonstrate that there is no interest in possession, but would also allow the survivor to keep down the value of their own estate. 

This route does comes with increased responsibility such as a heightened need to keep the will up-to-date and having to choose trustees. Additionally the costs and administrative burden of running a trust should not be overlooked.

Income tax and CGT planning

Severing joint tenancy is not just a deathbed tax planning opportunity. Tenants in common also allows for an unequal split of ownership, which can be a useful tool in income and capital gains tax planning. 

As with all tax planning, good record-keeping is imperative to clearly evidence the split in case of any HMRC queries. Married couples and civil partners would also need to inform HMRC of the split using form 17.

Note: this article applies to England and Wales only.

Victoria Harman is senior technical expert at Hargreaves Lansdown