The Residence Nil-Rate Band was introduced in April 2017, but the new rules are not as straightforward as some practitioners might have hoped. Imogen Freeman, Wills & Probate Solicitor, explores some of the issues.
Firstly, what is the Residence Nil Rate Band?
Every person has a Nil Rate Band (NRB) of £325,000. That is, any assets within that threshold are taxed at a nil rate of Inheritance Tax. Subject to certain exemptions and reliefs, the balance is taxed at 40%. Assets passing between spouses and civil partners are free from inheritance tax; any NRB unused by a spouse is transferred to the surviving spouse and the inheritance tax is deferred to the second death. (Spouse exemption can be limited where the domicile requirements are not met.) The Residence nil rate band (RNRB) is an additional tax-free allowance and is currently £125,000 per person. It will be increasing in £25,000 increments over the next couple of tax years, so by April 2020 it will be £175,000 per person. However, not everyone can utilise the RNRB. It only attaches to a residence passing to direct descendants, that is, children (including step, adopted and foster children) and grandchildren.
What if one passes all their assets to his or her spouse, with provision for children on the second death?
That is fine, the RNRB will still apply. The executors of the surviving spouse’s estate will need to make a claim to transfer the unused RNRB in the same way the existing NRB is transferred. Similarly, if one gives his or her spouse or civil partner a life interest in the residue, which includes a residence, with children to inherit on the termination of the life interest trust, both spouses’ RNRB’s can still be utilised provided the children or direct descendants inherit immediately on the life tenant’s death. The children will have to take absolutely; the RNRB will not be available if the children are given successive life interests. Will drafters will need to take care with the overriding powers of appointment, to ensure the children or grandchildren do take beneficially.
What about if assets are left to children and grandchildren via discretionary trusts?
If assets, including a residence, are left to children on a discretionary trust then the RNRB will not apply, even if the class of beneficiaries is limited to children and grandchildren. However, if specialist professional advice is taken swiftly after death and if the residence is gifted out of the discretionary trust to a direct descendent within 2 years of death the allowance can be used.
Does the RNRB apply to estates of all sizes?
Unfortunately not. Larger estates will not benefit from the RNRB. Where an estate is worth over £2 million, the RNRB will be tapered away by £1 for every £2 that exceeds £2 million.
What about second properties and buy to let properties?
Each person owning a residence qualifies for one RNRB only, even if more than one property is owned. The personal representatives will need to nominate to which property the relief will apply, if there is more than one qualifying residence. The property passing to direct descendants has to have been the deceased’s residence at some point during their lifetime, but there is no requirement for it to have been their main residence. If the deceased lived in the property but then moved into a care home for example, and subsequently let the property out to tenants, then the relief can still be applied.
Can I give away my property before I die to avoid paying inheritance tax altogether?
Not if you want to remain living in it! Many people think simply giving away their house will mean it does not form part of their estate for inheritance tax purposes, but this is not the case. If you give away your home and continue to live there, this is what is known as a gift with reservation of benefit, and so the value will still count when assessing the inheritance tax due. The only way to get around this is to pay a market rent to the new owner. This will have to be regularly assessed by letting agents to ensure it is a true market rent and not a sham to get around the rules. That being said, giving away your home is risky, as you expose it to any problems the person you give it to may face, such a matrimonial and financial difficulties, which means you could end up losing it.