The residence nil-rate band explained
On the 6 April 2017 the residence nil-rate band was introduced. This is an additional threshold for inheritance tax planning above the current £325,000 threshold.
- The residence nil-rate band was introduced from 6 April 2017.
- It is available to estates where the person dies after 6 April 2017 provided certain conditions are met.
- Any unused proportion of the residence nil-rate band may be transferred to a surviving spouse or civil partner where the survivor dies on or after 6 April 2017.
The current level of nil rate band, set at £325,000 from April 2009, has been frozen at that level ever since and is due to stay there until April 2026. Some 17 years of a frozen nil rate band and increasing property prices, even with the residence nil rate band, means many individuals will have an ever-increasing liability to inheritance tax.
Inheritance tax overhaul
The simplest approach would have been to raise the main inheritance tax nil-rate band by £175,000 to £500,000. However, the rules have created more complexity.
The residence nil-rate band is available to estates where the person dies after 6 April 2017 and:
- Leaves an interest in a residential property, which has been their main residence at some point, to their direct descendants on death.
- The direct descendants are children, which includes stepchildren, adopted and foster children, and their direct descendants.
- May include the spouse or civil partner of a direct descendant, or a surviving spouse or civil partner, if they have not remarried at the time of the deceased’s death.
It was phased in over four years, so the magical £1 million inheritance tax threshold for a married couple, £500,000 each, became a reality in April 2020, see below table.
The residence nil-rate band increase each tax year
|Resident nil-rate band increase
|Total inheritance tax allowance
Inheritance tax planning
Since the introduction of the residence nil rate band, potential inheritance tax liabilities will have to be recalculated for all individuals that are affected. Because the residence nil rate band is tapered away by £1 for every £2 if the estate is valued at £2 million or above, this can create a tax trap where the effective rate of tax is 60%. So, planning to restrict growth above this level can be effective.
If an individual dies within 7 years of making a lifetime transfer, it becomes chargeable. However, lifetime transfers are first of all set against the main nil rate band and inheritance tax could be payable if this is exceeded. But the residence nil rate band is not reduced by lifetime transfers and as result can still be used against the death estate.
For those who will not qualify, or where the estate is above the limit, which will be individuals with ‘net’ estates in excess of £2.35 million or last survivors with estates in excess of £2.7 million, they will need to consider alternative strategies to mitigate the inheritance tax liability.
It is important to consider whether an individual has direct descendants to whom they are able or want to leave a property. While not advocating that individuals start a family later in life, the residence nil rate band does seem to penalise couples who have made a lifestyle choice not to have children or have no direct descendants.
Can the nil-rate band be transferred between properties?
The amount of the residence nil-rate band personal representatives can claim is the lower of the net value of the interest in the property, or the maximum amount of the band. The amount is limited to one property, with personal representatives nominating which property should qualify where there is more than one property in the estate.
Any unused residence nil-rate band amount cannot be carried across to another qualifying property, and property that has never been a residence of the deceased, such as buy-to-let properties, will not qualify.
Any unused proportion of the residence nil-rate band may be transferred to a surviving spouse or civil partner where the survivor dies on or after 6 April 2017, regardless of when the first spouse died. Where the first death occurred before 6 April 2017, the residence nil-rate band is deemed to be £100,000, so the survivor’s estate will benefit from a 100% uplift.
It is crucial to consider the effect of any tapering of the inheritance tax allowance. If the net value of the estate (the value after liabilities but before reliefs and exemptions) is above £2 million, the residence nil-rate band is reduced by £1 for every £2 above that amount.
If the estate of the first to die is £2.35 million in 2022/23, they will lose all of the current £175,000 resident nil-rate band. For second deaths after 2020, where no residence nil-rate band was claimed on the first death, an estate of anything over £2.7 million could potentially lose both residence nil-rate band amounts of £175,000.
How does the nil-rate band apply if someone downsized their property?
Under the downsizing provisions, all or part of the residence nil-rate band might be lost because the deceased had downsized or ceased to own a residence on or after 8 July 2015. The residence nil-rate band will still be available provided the deceased left the smaller residence or equivalent assets to direct descendants.
What could have been a simple solution has not turned out that way, raising a number of questions and concerns for advisers and their clients. As ever, quality financial advice is paramount to ensure people are not left out of pocket.
Does buying a more expensive property ever make sense from an inheritance tax perspective?
Where a property is valued at less than the two residence nil-rate band allowances available to a couple, it may be worth considering ‘upsizing’. It may seem bizarre to consider that an older couple may look to buy a more expensive property to make full use of all the available £1 million inheritance tax allowance. However, this could save them a large sum of money.
Certain equity release schemes create a debt on the property and the residence nil rate band is only available on the ‘net’ interest. Alternatively, a scheme where part of the property is sold to release funds could make use of the ‘downsizing’ provisions.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.