Daniel Stevens muses over practical aspects of the downsizing provisions for inheritance tax residence nil-rate band purposes.
In April 2017, an extension to the inheritance tax (IHT) nil rate band was introduced. The idea is to remove the family home from the burden of IHT, or at least reduce the burden; however, it can also apply when the family home has been sold. What do you need to know?
Asset rich…cash poor
Property prices have been growing in a way that has outstripped earnings for over 40 years. Thus, many people now find themselves in the position where they have a relatively high capital wealth, but little or no liquid assets. Because the IHT nil rate band has not grown at the same rate, those with relatively modest estates have found themselves worrying about IHT – which used to be thought of as a tax for the wealthiest.
To counter this, the existing nil rate band can be extended to help shelter a main residence from the tax charge. Further details are given in a later article in this edition of Tax Insider (‘How To Claim The Residence Nil Rate Band’). However, in broad terms for the current tax year 2017/18, the extension is a further £100,000 per individual. This will rise in £25,000 increments in subsequent tax years until it reaches £175,000 in 2020/21 – meaning that a married couple could effectively enjoy a £1 million nil rate band in total – though the additional band will be tapered away if the estate exceeds £2 million. The extension is known as the residence nil rate band, and interestingly, it can potentially apply even where the house has been sold – for example, where a large house is sold and the occupant moves to assisted living accommodation.
Downsizing provisions
Where the property that was the occupant’s only or main residence is sold on or after 8 July 2015, the provisions serve to extend the available nil rate band by an amount known as the ‘downsizing addition’ in either of two situations:
- the property has been sold and the proceeds have been used to purchase a lower value property; or
- the property has been sold and not replaced.
In the first instance, the residence nil rate band (RNRB) will only apply if the new property is left to direct descendants (children, grandchildren, etc.). In the second instance, the direct descendants must inherit at least some assets from the estate.
How much?
Working out the additional threshold applicable is not straightforward. Broadly, it will be the amount of additional threshold that has been lost because the original home is no longer in the estate, but it also depends on other asset values, and whether a replacement property has been purchased.
HMRC’s guidance outlines a five-step calculation:
- take the level of RNRB that would have been available when the former home was disposed of (subject to a maximum of £100,000 for disposals in 2017/18 or earlier years);
- divide the disposal value of the former home by the result of step 1 and multiply by 100 to give a percentage. This is restricted to 100% so use that if the value of the home is greater than the result of step 1;
- if there is a home included in the estate, divide this by the additional threshold that would be available at the date of death (i.e. the maximum amount for the year, plus any transferred RNRB from a spouse), and multiply by 100 – again cap this at 100%. If there is no home in the estate the result will be 0%;
- deduct step 3 from step 2; and
- multiply the result of step 4 by the additional threshold that would be available at the date of death to give the lost additional threshold, and add this to the standard nil-rate band available.
Practical Tip:
The real practicalities and problems of applying the new RNRB will become apparent as issues arise with HMRC, but what is clear is that the detailed application is far more complicated than was assumed when it was first announced. Detailed guidance is available in HMRC’s Inheritance Tax manual at IHTM46000 and following (www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm46000), including some helpful examples of downsizing calculations.
