Under the current Inheritance Tax regime, on death the first £325,000 of each individual’s net estate is taxed at 0%. This is known as the “nil-rate band” (“NRB”). Unless any tax reliefs apply, the rest of their net estate is then taxed at 40%.
- Tax-free allowance of up to £650,000
- New additional allowance starts at £100,000 per spouse, increasing by £25,000 per year
For couples who are married or in a civil partnership, if the first to die has not used their full NRB, the allowance can be transferred to the surviving spouse, effectively providing them with a tax-free allowance of up to £650,000 on current values. This most typically occurs when the first to die leaves their entire estate to the surviving spouse, as gifts between spouses are completely exempt from tax.
On top of that, the government has introduced an additional “residence nil-rate band'” (“RNRB”) which came into effect on 6 April 2017. This additional allowance can be set against the value of a residential property (or a share of one) where the homeowner leaves the property to their children or other direct descendants, although this does include stepchildren, adopted children and foster children.
The additional allowance has started at £100,000 per spouse and will increase by £25,000 a year until 2020/21 when it reaches £175,000 per person. As with the normal NRB, married couples and civil partners are able to transfer any unused RNRB to the survivor. This will eventually allow a couple to pass up to a maximum of £1m to their children/issue tax-free by 2021 if they maximise the available allowances.
Generally speaking, in order to benefit from the RNRB, an individual must leave a residential property to their descendants. The new rules, however, also allow individuals to claim the RNRB if they had previously owned a residential property but no longer owned it at the time of their death. This means that people who have downsized or moved into a care home do not lose out, but they too can benefit from the additional allowance, up to the value of the residential property that they previously owned. The details of these rules are complex though, and care should be taken to make sure they apply in the right way.
It is important to note that the RNRB will only be available in full for estates under £2m. For estates that exceed this sum, the available RNRB will be reduced at the rate of £1 for every £2 by which the value of the net estate exceeds £2m. This year, estates that are valued over £2.2million will not benefit from the RNRB and, by 2021, estates over £2.35 million would not benefit at all.
Points to Note:
It does not matter if the first spouse to die did not own a residence: there is still an unused RNRB capable of being transferred on death.
It follows that, in the case where the first spouse’s death occurs before 6 April 2017, the RNRB will never have been used and hence is available for carry forward to be used on the death of the surviving spouse / civil partner.
To make full use of two RNRBs it is necessary for the survivor to have a residential property worth at least £350,000. If the property is worth less than that on the second death, then the relief will be capped at the value of the property.
It is also important to note that the relief only attaches to the equity in the property, ie the value left after deduction of any mortgage or other loan or charge secured on the property.
The “losers” in relation to the new RNRB are taxpayers with no children (eg two sisters living together and the property is inherited by the surviving sister) and taxpayers who rent a property and have chosen to invest their money into, for example, an investment portfolio or a portfolio of buy-to-let properties.
So, there are now essentially three “nil rate bands”, all with slightly different rules:
The “ordinary” NRB can be used against lifetime gifts and against any individual’s estate on death.
For married couples and civil partners, any unused NRB on the first death can be set against tax arising on the second death, but this will include:
- tax on any failed lifetime gifts (ie where the person who made the gift dies within 7 years of the date of the gift), and
- any additional tax payable on immediately chargeable lifetime gifts (eg gifts to a discretionary trust).
The Residential Nil Rate Band is only available to married couples and civil partners, and can only be set against tax arising on a spouse’s death provided that the relevant conditions are met.
Understanding the new nil rate tax band can be a challenge. If you would like to learn more, make an appointment to speak to Jane Whitfield at our offices in Queens Road, Reading, Berkshire, for a fixed-fee, one hour meeting costing just £95+VAT.