Inheritance Tax and Family Homes

The potential for family homes to be liable for inheritance tax (IHT) has always been a highly debated topic. The landscape around this topic altered with the introduction of ‘residence nil rate band’ (RNRB) from 6 April 2017.

The RNRB, which is designed to protect the family home from IHT, was introduced at £100,000 for deaths occurring in the 2016/17 tax year. It has been increased gradually over four tax years at a rate of £25,000 per annum until it reached £175,000 for the current tax year and will increase in line with the Consumer Prices Index (CPI) in subsequent years.

Just like the standard nil rate band, any unused RNRB on the first death of a married couple or civil partners can potentially be transferable even if the first death occurred prior to 6 April 2017. This means that where none of the standard rate band or RNRB is used on the first death, and the second death occurs on or after 6 April 2020, married couples or civil partners with a main residence worth at least £350,000 will be able to leave a total estate of £1m to children/grandchildren before any IHT is payable.

The introduction of the RNRB has had a significant impact on IHT planning strategies for anyone with children and an estate in excess of £325,000 (or £650,000 in the case of a married couple or civil partners) who will undoubtedly want to structure their affairs to make the most of this important opportunity.

Availability of RNRB

Whilst the standard nil rate band is available to everyone regardless of the structure of their estate or how it is to be distributed, the RNRB has several factors which could affect its availability.

The RNRB can only be utilised where somebody has had a qualifying residential interest (QRI) at some point during their lifetime. Simplistically, they need to own or have part ownership of a property that was their residence at some point during the period of ownership.

Buy-to let properties do not qualify as QRI’s, although a property that was once occupied by the deceased as a residence, but has been subsequently let to tenants, can be. Holiday homes, whether in the UK or overseas, could also theoretically qualify as QRIs if they are within the scope of IHT and have been used as a residence from time to time by the deceased.

Where the deceased owned more than one QRI and both are given away on death, the deceased’s personal representatives must nominate which one should be treated as the QRI.

A QRI will also need to be closely inherited to use the RNRB. This means that the property must be passed to direct descendants which includes:

• the deceased’s children or grandchildren;
• the spouses or civil partners of those children/grandchildren; or
• the widows/widowers, surviving civil partners of those children/grandchildren (if they have not remarried as at the date of the death of the property owner).

For these purposes, ‘children’ includes adopted, fostered and step-children. Effectively it includes any children for whom the deceased acted as guardian while they were under 18; and the children/grandchildren of all such children.

In some cases, property settled in trust on death for persons falling within one of the above categories will also be treated as having been closely inherited.

Notably, however, a property that is left to an unmarried partner will not be deemed to have been closely inherited; there is no IHT for property left to a spouse or civil partner.

Where RNRB is available, it is offset against the value of the estate passing on death and is restricted to the value of the QRI or, if lower, the amount of the QRI that is closely inherited.

Example – Ted

Ted has an estate worth £600,000 including a property valued at £250,000. He dies in August 2020 (when the RNRB is £175,000), leaving a 50% share in his house to Irene (his long-term, live-in partner) and the remaining 50% to his children from his first marriage. Ted’s estate will benefit from £125,000 of RNRB. This is because the RNRB is limited to the value of the QRI that is closely inherited. Ted’s estate would, of course, also benefit from the standard nil rate band of £325,000.

Estates in excess of £2 million

The available RNRB is reduced by £1 for every £2 by which the deceased’s net estate exceeds a certain threshold known as the taper threshold. The taper threshold was set at £2m initially and will increase in line with the CPI from 6 April 2021.

There are some planning opportunities available to reduce the impact of the tapering of the RNRB and more detail on this will be included in next week’s Newsletter article.