The Residence Nil Rate Band in a Nutshell
On 6th April 2017 a new, additional, Inheritance Tax (“IHT”) allowance will be introduced called the residence nil rate band.
What is it and how will it affect you?
The current position.
The basic starting point is that the first £325,000 of each estate (known as the “nil rate band”) is free of IHT. Certain types of assets are also free of IHT or taxed at a reduced rate, such as business property and agricultural property. Gifts to certain beneficiaries, such as a spouse or charity, are free of tax.
The £325,000 nil rate band is transferrable between spouses so a husband and wife or civil partners have a combined tax allowance of £650,000. Subject to the exemptions and reliefs mentioned above, anything over this is taxed at 40%.
And after 6 April 2017.
From April 2017 a new, additional, IHT allowance will be introduced (this is known as the “residence nil rate band”). This is an additional nil rate band which will be available over and above the basic £325,000. It will initially be £100,000 and it will increase by £25,000 in each of the next three tax years meaning that by 2020 the residence nil rate band will be £175,000. By 2020, therefore, a husband and wife or civil partners will potentially have a combined inheritance tax allowance of £1 million (£325,000 plus £175,000 x 2).
The new residence nil rate band will not apply to the larger estates, however, as it will be withdrawn on a tapering basis for estates in excess of £2 million.
What are the conditions to qualify for the residence nil rate band?
As the name suggests the residence nil rate band will be available to set against the value of a property which is, or has been, your residence. As a starting point, and, subject to the downsizing provisions referred to below you will need to own a residence or a share of a residence of sufficient value to cover the allowance.
The second condition is that the residence must be left to a direct descendant or descendants, either under the terms of your Will or under the intestacy provisions.
What is a direct descendant?
For these purposes, a direct descendant is:
- a child, a grandchild or other lineal descendant;
- a spouse or civil partner of a lineal descendant (including their widow, widower or surviving civil partner);
- a child who is or was at any time, a person’s stepchild;
- an adopted child of the person concerned;
- a child who was fostered at any time by the person concerned;
- a child where the person concerned is appointed as a guardian or special guardian for the child when they are under the age of 18.
The child inheriting the home does not have to be under the age of 18 and a stepchild is limited to someone whose parent is or was the spouse or civil partner of the person concerned. Direct descendants do not include nephews, nieces or siblings.
Will the Residence Nil Rate Band still apply if I sell my house?
There are downsizing provisions to say that where a house is sold the proceeds of sale can, in some circumstances, be “earmarked” and still qualify for the residence nil rate band. These provisions are designed to apply to people who downsize as they get older or sell their house to move into residential care and it will be important to keep clear records to show what the residence nil rate band is claimed against.
What are the traps/points to watch?
Like most changes to the tax laws, there are certain points to watch and potential traps to avoid including:
- The residence nil rate band can only be claimed against one property or an interest in one property.
- Where a husband and wife or civil partners own their residence in the name of only one or the other they may need to consider whether it would be better to own the property in joint names.
- Many people who have Wills containing trust provisions may need to review them.
- Some Wills containing gifts to descendants with age contingencies may prevent the residence nil rate band from applying by inadvertently creating trusts.
- If you own a holiday home it could in some circumstances be worth considering using it as your residence.
- Tapering provisions under which the residence nil rate band will be withdrawn for estates in excess of £2 million.
- If a husband and wife or civil partners have a combined estate in excess of £2 million it might no longer be sensible for each to leave everything to each other on the first death.
In conclusion, the residence nil rate band will potentially be a valuable new relief for many people but the devil is in the detail. The qualifying conditions and potential traps are not entirely straightforward. If you believe that the residence nil rate band may apply to you, you should take advice now to ensure that your affairs and your Will are suitably arranged. This will particularly be important if your existing Will contains trust provisions.
For further more in depth advice we have a fact sheet covering all you need to know in a nutshell contact our personal law team or email today to request a copy