Sarah Bradford considers the impact that the Chancellor’s announcement that the IHT nil-rate band and residence nil-rate are to be frozen until April 2026 may have on those looking to pass on their family home.
Inheritance tax (IHT) is only payable where the value of the chargeable estate exceeds the available nil-rate bands.
There are potentially two types of IHT nil-rate bands available – the ‘standard’ nil-rate band and the residence nil-rate band (RNRB).
The nil-rate band
The standard nil-rate band has been frozen at its current level of £325,000 since 2008/09. It was due for a review in 2021; however, along with a number of other allowances and thresholds, it is to remain at this level until April 2026 at the earliest.
Each spouse (or civil partner) is entitled to their own nil-rate band. In addition, the percentage unused on the death of the first spouse/civil partner passes to the surviving spouse and can be claimed by their executors on their death.
For example, if Mr A died in 2017, leaving £65,000 to his son and the rest of his estate to his wife, Mrs A, he would have used 20% of his nil-rate band of £325,000. This means that on Mrs A’s death, her executors can claim 80% of Mr A’s nil-rate band, based on the value of the nil-rate band at the time of Mrs A’s death.
Where the deceased leaves the full amount of their estate to their spouse, the surviving spouse’s estate benefits from two nil-rate bands (currently worth £650,000 in total) on their death.
Residence nil-rate band
The other nil-rate band is the RNRB. This is an additional nil-rate band which is available to shelter some or all of the main residence from IHT.
However, the RNRB is only available where the main residence is passed on to direct descendants, such as children and grandchildren. Step-children, adopted children, and foster children qualify, but nieces and nephews do not.
Further, the RNRB is only available in full where the value of the estate is £2 million or less. Where the value of the estate exceeds £2 million, the RNRB is reduced by £1 for every £2 by which the value of the estate exceeds £2 million.
The RNRB remains at its 2020/21 level of £175,000 for 2021/22. As with the nil-rate band, it is frozen at this level until April 2026 at the earliest.
Each spouse or civil partner is entitled to their own RNRB, and any unused portion can be claimed by the executors on the death of the surviving spouse or civil partner (i.e. as for the ‘standard’ nil-rate band). Provisions exist to preserve the availability of the nil-rate band where a person downsizes and passes proceeds from the sale of their former main residence to a direct descendant.
Sheltering the main residence
A single person will have a nil-rate band and a RNRB available to them and can pass on up to £500,000 free of IHT, as long as they leave a main residence to direct descendants that is valued at £175,000 or more, and the total value of the estate is not more than £2 million.
A couple are jointly able to leave an estate of £1 million (i.e. two nil-rate bands of £325,000 and two RNRBs of £175,000). Where the first to die leaves everything to the surviving spouse or civil partner, the surviving spouse or civil partner will have nil-rate bands of £1 million available on their death, provided that they leave a main residence worth at least £350,000 to direct descendants and their estate is not valued at more than £2 million.
It should be noted that a person can only have a maximum of two nil-rate bands and two RNRBs available to set against their estate on their death. This is the case even if a person has been widowed more than once, acquiring nil-rate bands from more than one former spouse or civil partner.
Freezing allowances and the main residence
The freezing of both the nil-rate band and the RNRB until April 2026 effectively means that more people will pay IHT, as the value of estates increase as a result of inflation and rising property prices. This can be particularly problematic where property is concerned, as property prices tend to increase over time.
For example, assume that Mrs B is a widow. Her husband died in 2018, leaving his entire estate to her. Her main residence is valued at £800,000 in October 2021. If she dies in 2021/22, she will be able to leave the main residence and further assets to the value of £200,000 before any IHT is payable, provided the main residence is left to direct descendants.
However, if she dies in 2024/25 when the main residence is valued at £1.1 million, IHT will be payable on the estate, even if she has exactly the same assets she had in 2021/22. The increase in value of the main residence has not been matched by an increase in the nil-rate bands, bringing her estate within the charge to IHT.
The following example looks at whether anything can be done to protect against an IHT charge on rising property values.
Example: Spouses as tenant-in-common
Mrs and Mrs Brown have been married for many years. They own their main residence jointly as tenants-in-common. This was a smart move on their part as it offers flexibilities not available where the main residence is owned as joint tenants.
Where a property is jointly owned as tenants-in-common, each owner owns a specific share of the property, and they can pass their share on independently. By contrast, where a property is owned as joint tenants, both individuals own the whole property, and where one joint owner dies, under the survivorship rules the surviving joint owner automatically owns the whole property.
Having taken professional advice, the couple rewrite their wills in 2021. Under the terms of each new will, their 50% share in their main residence is left to their daughter, and the rest of their estate is left to their spouse.
Mrs Brown dies in January 2022. At that time, their main residence is valued at £800,000. She has other assets valued at £100,000, which she leaves to Mr Brown.
On her death, her 50% share of the main residence is left to her daughter. This is valued at £400,000. As her daughter is a direct descendant, £175,000 is sheltered by the RNRB, and the remaining £225,000 is covered by £225,000 of her nil-rate band. The remaining £100,000 (31%) of her nil-rate band is transferred to her spouse.
Mr Brown dies in December 2025. At that time, the main residence (which is now owned 50% by him and 50% by his daughter) is valued at £1,000,000. He has other assets of £60,000. He leaves his entire estate to his daughter.
His estate is valued at £560,000 (comprising his 50% share in his main residence (£500,000) and other assets valued at £60,000). On his death, he has available his nil-rate band of £325,000, the RNRB of £175,000 and the transferable nil-rate band of £100,000 remaining from his wife’s estate – a total of £600,000. Consequently, there is no IHT to pay.
Compare this with the position that would have arisen had Mrs Brown left all her estate to Mr Brown. On her death, no IHT would be payable, and her nil-rate bands would have transferred in full to Mr Brown. On Mr Brown’s death, he left everything to his daughter. However, as his estate is worth £1,060,000 and he only has nil-rate bands totalling £1 million available, IHT of £24,000 (£60,000 @ 40%) is payable.
By owning the main residence as tenants-in-common and leaving your share to a direct descendant rather than to your spouse or civil partner, it is possible to gain some protection from IHT while the nil-rate bands are frozen.
However, it should be noted that if, in the above example, Mr Brown’s daughter sells the property following his death, she will be liable to capital gains tax on the increase in value in her share since she inherited it, if she has not lived in it as her main residence.
Practical tip
Plan ahead to gain protection from IHT if property prices rise while the nil-rate bands are frozen.
