The Residence Nil-Rate Band Explained

The new inheritance tax residence nil-rate band applies for deaths on or after 6 April 2017. Lindsey Wicks takes a look at the rules.

People have long been calling for an inheritance tax (IHT) exemption for the family home. We’re not there yet, but the new residence nil-rate band (RNRB) takes us one step closer for smaller estates.

Until the transferable nil-rate band came into force in October 2007, planning to create a nil-rate band discretionary trust on the first death of a couple was becoming commonplace to prevent modestly valued homes falling subject to IHT.

Despite the introduction of the transferable nil-rate band, with house prices on the increase and the IHT nil-rate band being static at £325,000 since 6 April 2009, the spectre of an IHT bill on death was starting to impact relatively small estates once again. The Conservative Party pledged to take the family home outside of IHT by raising the IHT threshold to £1 million if they won the May 2015 general election. It is this manifesto pledge that spawned the RNRB.

At the time of writing, we have another general election campaign underway. Whether there will be any changes depends on the outcome of the election. For example, the Liberal Democrats pledged to reverse the raising of the IHT threshold in their manifesto. The Labour Party indicated early in its campaign that it would lower the IHT threshold to £425,000 for couples. However, this was left out of the Labour Party manifesto.

Assuming that nothing changes post-election, the existing IHT nil-rate band is expected to remain at £325,000 until at least 5 April 2021. Given the ability to transfer an unused nil-rate band in a married couple or a registered civil partnership, this is effectively doubled to £750,000 for such couples.

To achieve the 2015 Conservative Party manifesto pledge of a £1 million IHT threshold, the new RNRB tops up the existing nil-rate band. The maximum amount of the RNRB will increase over the next four tax years as follows:

RNRB Tax year

£100,000 2017/18

£125,000 2018/19

£150,000 2019/20

£175,000 2020/21

This means that by 2020/21, an individual can have a nil-rate band of £325,000 plus an RNRB of £175,000, making a total of £500,000. Similar to the IHT nil-rate band, any unused RNRB is also transferable within a couple, taking the total for a couple to £1 million.

There is a withdrawal of the RNRB at a rate of £1 for every £2 over a tapering threshold for estates with a net value of more than £2 million. 

It might be that the estate of the first spouse would have been below the tapering threshold and therefore the full RNRB would have been available to them. However, if on the death of the second spouse, their total estate is worth more than £2 million, the value of any unused RNRB from the first spouse will be tapered. 

Surviving spouses need to be aware of the size of their estate, and should consider planning that will keep them below the £2 million threshold.

The RNRB is only available on death and not for lifetime gifts. It is available to taxpayers with a qualifying residential interest (QRI) at the time of their death, which passes to their direct descendants (referred to in the legislation as being ‘closely inherited’).

A QRI is an interest in a dwelling-house that is included in the person’s estate immediately before their death and that dwelling-house has been their residence at a time when they had an interest in the property. It is worth noting that the interest held immediately before death does not have to be the same interest that was held at the time of residence. 

Where a person’s estate comprises interests in more than one dwelling-house that has been their residence, the deceased’s personal representatives can nominate one (and only one) property to be the QRI. The QRI extends to gardens and grounds without restriction save for any trees or underwood for which a deferral election is made (under IHTA 1984, s 125). The legislation does not define residence or dwelling-house, but these have been the subject of cases involving capital gains tax private residence relief.

To be closely inherited, the property must be inherited by a lineal descendant, or spouses or civil partners of lineal descendants (including widows and widowers of lineal descendants provided they have not remarried or formed a new civil partnership). A lineal descendant includes step-children, adopted children, foster children, and children under guardianship and special guardianship. 

The property is inherited if there is a disposition of the property to the lineal descendant (either by will, intestacy, or other legal means). If the property becomes settled property, the lineal descendant will only be treated as inheriting the property if they have an interest in possession that is an immediate post-death interest (IPDI) or a disabled person’s interest, or if the property is held in a trust for their benefit and it is either a trust for bereaved minors (IHTA 1984, s 71A) or an ‘18-25 trust’ (IHTA 1984, s 71D). If the property was settled property in which the deceased had an interest in possession, the lineal descendant will inherit if they become beneficially entitled to the property on their death.

Leaving a QRI in trust for grandchildren will not qualify for the RNRB if the above trust types are not in point. An example of a trust that would not qualify includes where there is a contingency such that the grandchildren can only inherit upon reaching a certain age.

It is not uncommon for people to downsize or even sell their home before their death. Recognising that the RNRB could prejudice this group, the scope of the relief was expanded to include downsizing moves or disposals that take place on or after 8 July 2015. The aim of this relief, known as the downsizing addition (DA), essentially means that the same level of relief should be available as if the original property had been retained.

In essence, to qualify for the DA, in the case of downsizing, the value of the QRI on death is less than it would have been if a previous residence had been retained and other assets (in addition to the QRI) are closely inherited. Where the QRI has been disposed of without replacement, the deceased must have held a residence that would have qualified for the RNRB and some of the assets of the estate must be closely inherited. The DA is effectively the RNRB lost as a result of downsizing or disposal, but is limited to the value of the assets that are closely inherited.

The concept is relatively simple, but the legislation to calculate the downsizing addition is complex – particularly given that the taxpayers most likely to be relying on the relief will probably be unrepresented. HMRC has created a number of case studies related to the calculation of the RNRB and case study numbers 11-18 relate to the DA (see www.gov.uk/government/case-studies/inheritance-tax-residence-nil-rate-band-case-studies).

Claims for allowances transferred from a spouse and claims for the DA must be made within two years from the end of the month of death or within three months of the personal representatives starting to act, whichever is later. HMRC may allow a longer period for making a claim.

Relying on the RNRB to shelter the value of the family home from IHT will not be the panacea for everyone – particularly those with estates exceeding the tapering threshold. In those cases, other forms of IHT planning for the home should be considered, for example, gift and leaseback and reversionary lease planning.