With significant increases in property prices and static inheritance tax (IHT) allowances, many more people will be dragged into the IHT net. This article looks at an allowance that may help to minimise your IHT liability.
IHT – the basic position
Broadly speaking, on death an estate will be subject to IHT at 40% on the excess over the available nil rate bands, unless reliefs or exemptions apply. For married couples and civil partners, there is usually no IHT on the first death due to the spouse exemption. IHT may be payable on the second death when the estate passes to non-exempt beneficiaries such as children or grandchildren.
Nil rate bands
There are two nil rate bands:
- The ordinary nil rate band of £325,000 which applies to lifetime gifts and the estate on death. It has been fixed at £325,000 since April 2009 and will remain so until at least April 2026.
- An additional nil rate band known as the residence nil rate band (the RNRB) which was introduced in April 2017 for those who leave a qualifying residence on death to direct descendants. It currently stands at £175,000 (for deaths on or after 6 April 2020) and will not increase until at least April 2026.
Both are transferable to the surviving spouse on death. This means that married couples potentially have total nil rate bands of £1m on the second death. However, this depends on a number of factors.
Limitations to the residence nil rate band
The RNRB will prove a valuable allowance for some, but the legislation is complex and there are various limitations that restrict its availability. There are also traps for the unwary.
- It only applies to those who own a ‘qualifying residential interest’ on death – broadly speaking, a property or an interest in a property that the taxpayer occupied as a residence at some point (not necessarily at death).
- The property must be left on death to ‘lineal descendants’ – this means children and grandchildren and includes adopted children, stepchildren and foster children and also their spouses and civil partners. The RNRB is unavailable to those without lineal descendants.
- It can only apply in full where the estate on death does not exceed the ‘taper threshold’ – currently set at £2m. If the estate exceeds that figure, the RNRB is reduced by £1 for every £2 of excess. For married couples this means that if the survivor’s estate is £2.7m or more, the benefit of the RNRB will be lost. IHT reliefs are not deducted to establish the value of the estate for taper threshold purposes, but lifetime gifts are, regardless of when they were made.
- It does not apply to certain types of trust e.g. discretionary trusts and trusts for grandchildren until they reach a specified age. However, if such trusts arise, it may be possible for matters to be rearranged within two years of the death to secure the benefit of the RNRB.
- Downsizing relief may apply if a property has been sold or given away during lifetime.
There may be steps you can take through your will or otherwise to preserve the availability of the RNRB. For these reasons and more it is always wise to keep your will and your IHT position under regular review.