‘The residence nil rate band is too complex and people struggle to understand it’.
These were the findings of Office of Tax Simplification (OTS) in their report on simplifying inheritance tax. The residence nil rate band (RNRB) attracted more comments than any other area of IHT during the review. However, the OTS concluded that as the RNRB is still relatively new, it should be given a chance before any recommendations on simplification are made.
But for now, you will have to play to the current rules to get the most from the allowance. Being able to leave their children an extra £175,000 IHT free, double that for married couples and civil partners, is very appealing. But it’s crucial that certain conditions are met to make this a reality.
Essentially, there must be a ‘home’ to leave in the first place. But who receives it and the value of the estate at death can both affect eligibility. There are also rules which can allow the extra nil rate band to be claimed if the property has been sold or gifted before death. So not everyone will benefit from it and this is what makes it complicated.
In our experience, the main areas that cause confusion are:
1. Property must be ‘closely inherited’
In order to qualify for the additional nil rate band, the property must be closely inherited. Generally this means the property must go to the deceased’s child or other direct descendant such as a grandchild or great-grandchild. It may also include the spouse or civil partner of a descendant. This makes it possible for a house to be left to a couple without jeopardising the RNRB.
The definition of children is also wide enough to include adopted, foster and step-children. An individual can still be regarded as a step-child even if they were an adult when their parent re-married.
This increases flexibility with regard to who gets what from the estate and when, without failing the ‘closely inherited’ test. For example, Jack and Jill marry, both with two children from a previous marriage. Their wishes are that on the first death, the house will pass to the survivor, but on the death of the survivor, the house will be left equally to the four children. This can be achieved without losing any RNRB.
2. Is there a will?
Children don’t need to physically take ownership of bricks and mortar to qualify. The deceased’s will may make specific reference to the home being passed to a direct descendant. But even if there’s no specific direction and the home simply falls into the residue of the estate, the RNRB can still be claimed, provided a share of the residue passes to direct descendants.
If the will leaves the home to a trust rather than a direct descendant, RNRB can still be claimed if the value of the trust property is included in the beneficiary’s own estate for IHT. For example, if the will creates a bare trust or a trust with a qualifying interest in possession (also known as an immediate post death interest, or IPDI).
There’s no RNRB available if the home passes into a discretionary trust or a trust where a direct descendant’s rights are contingent upon them attaining a particular age.
However, if the home has been left to a discretionary trust, it may be possible to recover the RNRB if the trust assets are paid out to a beneficiary who is also a direct descendant within two years of death.
3. Transfer between spouses
Much like the standard nil rate band, any unused residence nil rate band can be transferred to a surviving spouse or civil partner. The RNRB cannot be transferred between unmarried couples. But there are several quirks behind transferring the RNRB.
It doesn’t matter when the first spouse died. Additional allowance may still be claimed even if they died before the introduction of the RNRB.
It doesn’t even matter if the deceased ever owned residential property. When their surviving spouse dies, their executors will still be able to claim 100% of the prevailing RNRB. So if the first death occurred in 2010, and the surviving spouse died in the 2020/21 tax year, the executors could make a claim to transfer £175,000.
Only where the estate on the first death was greater than £2M may the ability to transfer 100% of the RNRB be lost. Any tapering of the allowance where the first death was before 6 April 2017 will be based on an assumed RNRB of £100,000.
High value estates above £2M will see the RNRB tapered for £1 for every £2 above this threshold. This means that the current RNRB of £150,000 would be lost completely if the estate is greater than £2.3M. And from the tax year 2020/21, the RNRB of £175,000 will be completely lost if the estate is greater than £2.35M.
And don’t forget that the any transferred RNRB may also be tapered on the second death. Consequently, someone with a full RNRB from a former spouse will lose both allowances once the surviving spouse’s estate exceeds £2.6M this year (or £2.7M from 6 April 2020).
What is included in the estate for IHT doesn’t mirror what is used to determine whether the taper threshold has been breached.
Gifts made in the seven years prior to death will form part of the estate for IHT. However, they don’t affect the tapering of the RNRB. This means some death bed planning may be possible which could save as much as £120,000 in IHT if both RNRBs can be retained by making gifts before death.
Conversely, assets which may be IHT free due to the availability of business property relief or agricultural property relief, do need to be included to test whether tapering applies.
Perhaps the least understood aspect of the RNRB are the downsizing provisions. These ensure that those who may have moved to a smaller property in later life, or no longer own a property (e.g. in residential care or living with a relative), are not disadvantaged.
A downsizing addition is available to replace the RNRB which may be lost as a result of moving to a lower value property or no longer owning any property, provided the disposal took place after 8 July 2015. In most cases, where the value of the property sold is more than the RNRB at that time, the downsizing addition plus the value of any property still owned will equal the RNRB and so the client will be no worse off. Where the value of property sold is less than the RNRB at the time, the downsizing addition will be proportionately reduced.
However, assets from the deceased’s estate to the value of the downsizing addition still have to pass to direct descendants.
6. Claiming it
The RNRB can only be claimed on death and does not apply to lifetime gifts. Therefore it’s down to the executors to gather the information needed and complete the IHT435 and also the IHT436 if unused transferable RNRB is to be claimed.
It will clearly make the executor’s job easier if all the information needed is gathered in advance. In particular, the details of a deceased spouse’s estate will be useful, along with the dates and property values on any property which has been disposed of due to downsizing.
Getting In Touch
If you’d like advise on RNRB, an inheritance or to discuss your investments, then please contact John Tamblin via the contact form or you may contact him directly on 07880 795710 for a no-obligation chat.