From April 2017 the Inheritance Tax (IHT) Nil Rate Band (NRB) will be supplemented by the Residential Nil Rate Band (RNRB) when a residential property is left to direct descendants on death.
The RNRB will initially be worth £100,000 and increased by £25,000 per annum so that from April 2020 it is worth £175,000. For a married couple it will eventually be possible to leave assets worth £1million without paying IHT. However, if the value of a person’s estate exceeds £2million the RNRB is tapered by £1 for every £2 over. The value of the estate is assets less liabilities, but before reliefs such as Agricultural Property Relief and Business Property Relief.
Where a taxpayer has more than one residence, the personal representatives can make an election to nominate which property is covered. Unlike for CGT, there is no restriction on the size of the garden or grounds nor a requirement that the property has been occupied as a residence throughout the period of ownership. Where a taxpayer has sold a residence after 8 July 2015, downsizing relief is available to ensure that assets representing the value of the residential property qualify for the RNRB. However, downsizing relief is limited to the RNRB available at the time of downsizing, and is currently £100,000.
For a property to qualify for the relief, it must be ‘closely inherited’ on death and left to a lineal descendant i.e. children or grandchildren or their spouse. This includes step, adopted and foster children. If the property is left on trust, the terms of the trust must give the lineal descendant a life interest or be a vulnerable beneficiary or bereaved minor trust for the lineal descendant. If property is left to a discretionary trust the RNRB will not be available.
Like the NRB, the RNRB can be transferred between spouses. The RNRB is available irrespective of when the first death occurred, as long as the second death is after 6 April 2017.
There are a number of planning opportunities to consider. The RNRB is tapered if the estate exceeds £2million, so husband and wife should equalise their estates as far as possible to ensure that both are valued at less than £2million. Where the combined estate exceeds £2million it may be appropriate to use a NRB trust on the first death to reduce the value passing to the surviving spouse.
The value of a residential property is calculated after deducting liabilities. If the net value of the property is less than the available RNRB it may be possible to increase it by restructuring the debt.
As mentioned above, an abatement of the RNRB will occur if the estate on death exceeds £2million. Gifts in the seven years prior to death are not included in the value of the estate for these purposes so there could be an opportunity for deathbed lifetime gifting, potentially protecting the RNRB. The gift will, however, still form part of the estate when looking at the IHT payable as it will be treated as a potentially exempt transfer (PET).
With all planning ideas, care should be taken to ensure that there are no unexpected tax consequences. Whilst the RNRB can potentially save £140,000 IHT and enables assets of up to £1million to pass free of IHT, there are plenty of traps for the unwary, and professional advice should be taken.