There are arguably only two things certain in life: death and taxes. It is therefore unsurprising that you may be keen to mitigate your exposure to the mechanism which encompasses both: Inheritance Tax (IHT). In doing so, you may consider your most valuable asset, which is most likely to be your home, and how it can be utilised in your tax planning?
In summary, each individual has a ‘nil rate band’ (NRB), currently £325,000. IHT on assets up to this value is charged at 0%. To the extent that it is unused, the NRB is transferrable to a surviving spouse on the second death. The current combined maximum NRB between spouses is therefore £650,000.
In April 2017, the Government introduced a new additional nil rate band, called the ‘residence nil rate band’ (RNRB), which applies in certain circumstances where residential property is owned. The current RNRB allowance is £125,000 for the 2018/19 tax year and will increase by £25,000 each tax year until it reaches £175,000 in the 2020/21 tax year. The RNRB is also transferable between spouses to the extent it is not used on the first death. This means that in 2020/2021 the maximum combined NRB and RNRB between spouses will be £1m.
To the extent that no other exemptions or allowances are available, IHT is charged at 40% on the balance of your estate over the NRB and RNRB and any transferrable NRP and RNRB.
Gift of your property – lifetime
You may have considered making a gift of your property to reduce your IHT liability, perhaps transferring your property into your children’s names during your lifetime but continuing to reside in it.
For IHT purposes, this would be a gift with reservation of benefit (GROB) – essentially a gift of an asset that you continue to derive a benefit from. Broadly speaking, if you have made a GROB the value of the asset given away during your lifetime will be treated as remaining in your estate on death for IHT purposes, unless you pay full market rent for your occupation.
From a Capital Gains Tax (CGT) perspective, to continue benefiting from the main residence exemption, the recipient of the gift would have to reside at the property with you, which may be unsuitable. Furthermore, the automatic uplift to the market value for your home on death would be unavailable and the recipient’s base value for CGT purposes would be the value of the property as at the date of the gift.
From an Income Tax perspective, if you pay full market rent to the recipient for your continued occupation of the property, the recipient may have to pay Income Tax on the rental income.
Other risks include the relationship between you and the recipient breaking down. For example, you could find yourself without a home and without the funds to purchase a new property, or the recipient’s own family relationships could break down, with your property an asset in the divorce proceedings, or they could go bankrupt, with the property again forming an asset of their estate.
Gift of your property – on death
Instead of making a gift of your property in your lifetime, you could consider giving some or all of your interest in your property on death, to utilise your RNRB.
To make us of the RNRB in full on your death, you must own qualifying property, pass your interest in the qualifying property to your children (or direct descendants) and have an estate of less than £2m in value. You may therefore need to consider changing how you hold property and the terms of your will so that your property could pass to your direct descendants on your death.
For example, if you are married and your combined estate is just over £2m, you could consider utilising the RNRB on the first death to ‘bank’ it at that stage. You may therefore need to amend the terms of your will, so that on the first death a percentage of the property passes to your direct descendants rather than to the surviving spouse, but noting this is only possible if the property is held as tenants in common. You could also consider ‘equalising’ your estates by transferring some of the assets between you to bring both of your respective estates within the £2m threshold. If the property is held as joint tenants (meaning that instead of the property passing in accordance with your will, it will pass automatically to the surviving owner(s)) then the ownership structure of the property can be amended and we can also assist with that step.