The residence nil-rate band explained

The residence nil-rate band

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. When the residence nil-rate band was introduced, in April 2017, it was initially, set at £100,000 but increased by £25,000 each year until it reached £175,000 in April 2020. 

However, like the standard nil-rate band it has been frozen at that level ever since and is due to stay at that level until April 2031.

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.
• Direct descendants are children, grandchildren, and remoter descendants. This includes stepchildren, adopted or foster children and children to which the deceased was a guardian, and their direct descendants.
• Direct descendants also 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 should be noted that direct descendant doesn’t include nieces, nephews, siblings, aunts, uncles, parents etc.

Residence nil-rate band taper

Only estates less than £2 million will benefit from the full residence nil-rate band. Where the estate is over £2 million entitlement to the residence nil-rate band is tapered away at a rate of £1 for every £2 over. 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.

When considering whether the £2 million threshold has been breached you look at the value of the assets “owned at the time of death”. This means that you ignore reliefs (business and agricultural relief) and any gifts made by the deceased, even if they were made within seven years of death.

Inheritance tax planning

If an individual dies within 7 years of making a lifetime transfer, it becomes chargeable and needs to be included in the deceased’s IHT calculation. These transfers need to be set against the standard nil-rate band. If the transfers exceed the standard nil-rate band then inheritance tax could be payable. If the deceased is entitled to the residence nil-rate band this would then be available to use against the death estate. It should be noted that the residence nil-rate band cannot be set against “failed” lifetime transfers.

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. This means that any outstanding mortgage or loan against the property needs to be deducted to arrive at the net value to be used.

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 or they owned a residential property. The only check that needs to be undertaken is the £2 million threshold. 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 (provided the value of the first spouse’s estate was under the £2 million threshold).

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’ value. Alternatively, a scheme where part of the property is sold to release funds could make use of the ‘downsizing’ provisions.