Taking advantage of the residence nil rate band to benefit from the full £1m IHT allowance
Tax arrangements following a death can be complex and cause unnecessary worry, writes NICK GILES, a consultant with accountancy firm Page Kirk. It's important to understand the rules and to take professional advice.
When asked, most people will tell you that you do not pay inheritance tax (IHT) on an estate worth less than £1m. Whilst this can be true, it is worth revisiting where this figure comes from and the steps people should take to ensure they benefit from these rules.
Firstly, this figure will always be quoted with reference to married couples or civil partners. An individual can have an estate valued at £325,000 or less and not pay any IHT, as this amount is covered by what is called the “nil rate band”. This tax-free amount can be transferred to a surviving spouse if they leave all of their assets to their spouse, potentially giving a surviving spouse a nil rate band of £650,000.
The remaining £350,000 comes from the “Residence Nil Rate Band” (RNRB) which is currently set at £175,000 per individual and, like the nil rate band, can be transferred if not used, to give a surviving spouse an RNRB of £350,000. The RNRB works in a similar way to the nil rate band, in that is deducted from the value of the deceased's estate before calculating IHT, but there are a number of rules and conditions that must be satisfied if an individual is to benefit from the RNRB.
The main qualifying conditions are that an estate contains a “residential interest” which has, at some point, been the deceased's private residence and that the residence is “closely inherited”, which means it is left to lineal descendants, such as children, grandchildren etc.
This article will focus on the first condition, which often raises some complications in practice. As stated, to qualify for the RNRB there must be a residence in the estate that has been the deceased's main residence at some point. Furthermore, whilst the RNRB is given as a deduction against the estate as a whole, the RNRB amount is capped at the value of the qualifying residence.
The conditions do not stipulate that the RNRB has to be claimed against the deceased's residence at the time of death, and it can be possible for there to be more than one potential qualifying property in the estate. For example, a previous residence may have become a rental property and be in the estate alongside the deceased's main residence. Executors should therefore ensure that they nominate the highest value property in the estate on which the RNRB is claimed, to maximise the tax relief available.
Further issues often involve the sale of an individual's main residence in their lifetime to either downsize to a smaller, less valuable property or to move into a care home. In the absence of any rules to the contrary, this could mean that entitlement to the RNRB is reduced as it is capped against a lesser-valued property or lost entirely, as there is no longer a qualifying residence in the estate. This can cause concern for individuals and families, who may feel that they will be penalised with additional tax through having to make normal, but often difficult, decisions with regard to housing in old age.
Thankfully, there are additional provisions known as the “downsizing rules” which work to preserve an individual's entitlement to the RNRB. The rules broadly work by looking at the percentage of the RNRB that would have been available against the “old” residence and applying that percentage to the RNRB that is in force at that time, which can then be deducted from the deceased's estate.
As an example, a married couple may have a home worth £400,000. One spouse dies and leaves their half in the property to their surviving spouse. The home is too big for one person to live in, so the surviving spouse sells the house and buys a new, smaller property which on their death is worth £200,000. Initially, the value of the RNRB available to the estate is £200,000. However, the executors can look at the value of the old residence and make a claim for a “downsizing addition”. In this instance, had the RNRB been available against the old residence, 100% of the RNRB would have been available, providing a current deduction of £350,000. The executors can therefore claim an addition of £150,000 against the estate.
The same treatment would apply if there were no residence in the estate, perhaps because the individual has moved into a care home. All of the RNRB calculated with reference to the old property would still be available to deduct from the value of the individual's estate.
These rules are often not known or understood but can offer peace of mind when it comes to making plans in old age. Page Kirk have a wealth of experience in IHT and the impact it can have on your family and can offer a full review of your situation to ensure you are set up to leave as much as possible to your loved ones.
Contact the Page Kirk Team on 0115 955 5500 or email enquiries@pagekirk.co.uk.