Malcolm Finney reveals that the inheritance tax ‘residence nil rate band’ rules are not quite as helpful as might have been expected.
The Conservative manifesto promised to increase the inheritance tax (IHT) nil rate band to £1 million for married couples. What has actually been introduced is not quite as expected.
Residence nil rate band
The so-called ‘£1 million nil rate band’ does not exist!
What the government has done is to retain the current £325,000 nil rate band, but introduce in addition a new so-called ‘residence nil rate band’ (RNRB) available to those who own (or have owned) a residence/home. The amount of the RNRB is to be phased in over four tax years as follows: £100,000 for 2017/18; £125,000 for 2018/19; £150,000 for 2019/20; and £175,000 for 2020/21 (for ease in the following examples the final £175,000 RNRB is used).
However, if an individual does not own (and has never owned) a home (as in Example 1) then that individual is not entitled to the RNRB.
Example 1: Rented accommodation
Mr and Mrs Smith have an aggregate estate of £1 million.
However, they do not own (and never have owned) a home, having lived in rented accommodation all their lives.
On their deaths IHT will be levied at 40% on £350,000 [£1 million less £650,000], i.e. £140,000.
Example 2: Own home
Mr and Mrs Brown also have an aggregate estate of £1 million (but this includes their own home worth £350,000).
On their deaths no inheritance tax will be levied (assuming, broadly, their children/grandchildren inherit their home; see below).
As indicated above, entitlement to the £175,000 RNRB requires that the deceased owns (or has owned) an interest in a property which must have been the deceased’s residence (i.e. a home) at some point during its ownership (thus exclusive buy-to-lets are excluded). In addition, the residence must be inherited by one or more lineal descendants (e.g. children (including stepchildren, foster children and adopted children), grandchildren) of the deceased on death.
The RNRB applies where a surviving spouse (or both spouses) dies on or after 6 April 2017.
Denial of RNRB
Leaving the residence by will to (amongst others) brothers, sisters, nephews, nieces, friends, relatives, parents or grandparents will mean that entitlement to the RNRB is denied. Leaving a residence on trust (e.g. discretionary trust) needs careful consideration, as this may also result in a denial of the RNRB.
Childless couples are also denied the RNRB.
Example 3: Married couple
Mr and Mrs Charles each have an estate of £500,000 of which £175,000 is the value of their home. Their home is held as joint tenants.
On his death, Mr Charles’ 50% in the home passes automatically to Mrs Charles. This constitutes an inter-spouse transfer and no IHT arises on this element of Mr Charles’ estate. By will, he leaves the remainder of his estate to Mrs Charles (again no IHT charge).
On Mrs Charles’ subsequent death, there is entitlement to her own £325,000 nil rate band, plus the unused £325,000 of Mr Charles. In addition, Mrs Charles has her own RNRB of £175,000 plus that of Mr Charles.
On her death, she leaves the home (worth £350,000) to their daughter, and the rest of her estate (£650,000) to her sister. No IHT arises on the home as the £350,000 total RNRB may be used against it; and her combined nil rate band of £650,000 is off-settable against the remainder of her estate worth £650,000.
No IHT arises.
Now consider the identical scenario, where a couple are co-habitees.
Example 4: Co-habitees
Mr Smith and Ms Charles (co-habitees) each have an estate of £500,000 of which £175,000 is the value of their home. Their home is held as joint tenants.
On his death, Mr Smith’s 50% in the home passes automatically to Ms Charles, and by his will he leaves the rest of his estate to her. Neither transfer constitutes an inter-spouse transfer. Mr Smith is entitled to the £325,000 nil rate band, but not the £175,000 (as his interest in the home does not pass to a lineal descendant of his).
IHT thus arises on his estate equal to 40% of £175,000 [£500,000 less £325,000], i.e. £70,000.
On Ms Charles death, she leaves everything to their son. Her estate amounts to £930,000. She is entitled to the nil rate band of £325,000 and the RNRB of £175,000. Thus, £430,000 is within the charge to IHT, resulting in a charge of £172,000.
Transfer of unused RNRB
Any unused element of the RNRB (as with the nil rate band) on the death of the first spouse is transferable on death of the second spouse (but not between co-habitees).
Practical Tip:
Wills may need to be re-examined in order to ensure where necessary that the newly introduced RNRB will not be wasted.
