Inheritance tax (IHT) has been around for more than 300 years. In its current form it replaced the old Capital Transfer Tax, which had been developed with a philosophical basis – to protect the poor by deliberately redistributing inherited wealth through taxation.

Less than 5% of estates are liable to IHT, yet more money is being raised by it. Total HM Revenue & Customs receipts from IHT stood at £5.2bn in 2017/18 a record high – significantly more than double the £2.4bn raised in 2009/10. House price inflation is the primary cause – prices have risen by more than 60% in the last eight years.

Residence Nil Rate Band (RNRB)

In July 2015 Chancellor George Osborne announced significant changes to the IHT regime: If you owned a property worth up to £1m you would eventually be able to leave it to your children or grandchildren completely free of IHT. The Residence Nil Rate Band Allowance (RNRB) would raise the IHT threshold, which was introduced in stages from April 2017 onwards for individuals who satisfy the criteria.

In the current tax year, the RNRB provides an additional IHT allowance of £125,000. This will increase by £25,000 in the next two tax years so that, by 2020/21, the RNRB will be £175,000. Without RNRB, the 2018/19 tax-free IHT allowance remains at £325,000 – the same figure as eight years ago, with no current plans to increase it. For a married couple, from April 2020 a joint estate of up to £1m on second death could potentially be passed on IHT free.

Direct Descendants

In general, an estate will only be able to claim the RNRB where a house is left to ‘direct descendants’ (or downsizing provisions apply). A ‘direct descendant’ is broadly speaking a child/grandchild of the deceased, including step and adopted children. The definition also includes spouses of direct descendants.  Where property is to be split between direct descendants and non-direct descendants the RNRB will be restricted to the value of the part left to the child/grandchild.

Will Trusts

Individuals may have planned to leave part or all of the property to a discretionary trust on first or second death. The RNRB will not be available to the estate where property is left to a discretionary trust.  This is because direct descendants have not inherited a right to the property.  This is the case even if all the discretionary beneficiaries qualify as ‘direct descendants’.

Where property has been left to a discretionary trust, the trustees may agree to wind up the trust and transfer the property to direct descendants. If this is done within 2 years of the date of death, RNRB may be claimed by the estate in the same way as if the property had always been left to the individuals directly.

Where a property is left to a discretionary trust on first death, or an Immediate Post Death Interest trust has been set up, and the surviving spouse has the interest-in-possession, the unused RNRB is transferable to the spouse and may be able to be utilised on their death.

Care should be taken with a property left on a contingent trust, for example ‘to such of my granddaughters as reach the age of 30’. The residence NRB would be lost if the granddaughters have not reached the specified age at the time of death.

We recommend any wills which place the family home into trust should be reviewed to see if it continues to meet their intentions and remains the most tax-efficient option for the client.

Making Gifts

The main residence nil rate band cannot be used with a lifetime gift of property. If death is within 7 years of the gift, only the main IHT nil rate band (where not used against other transfers) can be set against the transfer of property. However, if the gift was made after 7 July 2015 downsizing provisions may allow the RNRB (or an element of it) to be used where sufficient assets are left on death to direct descendants.

Downsizing

Where the family home was disposed of after 7 July 2015, it may be possible to claim a downsizing adjustment. This can apply where the deceased moved to a lower value home or sold or gifted their home and no longer owned a home on their death.

The sale proceeds don’t need to be ring-fenced to leave to direct descendants on death, as long as assets of equivalent value are left to children/grandchildren. The RNRB will be capped at their value, so it could be lost if there are insufficient funds left in the estate to direct descendants to utilise it.

Good record keeping is essential:

• Ensure Legal Personal Representatives (LPRs) are aware of any lifetime gifts/sale of property so that any downsizing adjustment can be claimed.
• Care needs to be taken that lifetime gifts of property or cash arising from the sale of the property are considered in the light of the downsizing provision, the overall IHT position of the estate and any long term care funding issues.

High Value Estates

The wealthiest estates may not be able to benefit from the residential nil rate band. Estates worth over £2m will start to lose the RNRB, with it being withdrawn at a rate of £1 for every £2 over £2m. The taper test is applied on each death, including those before 6 April 2017.

It is not the value for IHT which is used to test whether tapering applies. The IHT value will also include certain assets and transfers which may be exempt from IHT.

These include:

• Property passing to the spouse.
• Assets qualifying for business property relief or agricultural relief.

However, for tapering purposes the value of lifetime gifts are excluded, even if made in the 7 years immediately before death. This allows gifts right up to the point of death to bring the value used for tapering below the £2M threshold.

Claiming IHT Relief

Like the transferable nil rate band the RNRB must be claimed within 2 years of the end of the month of death.  This will require the LPRs to have access to information about family relationships, residence ownership and history (particularly if there is a claim for downsizing relief, or LPRs make a claim to nominate one property rather than another qualifying home). The LPRs must submit details about the previously deceased spouse’s estate and marriage to claim both the transferable residential nil rate band and the main IHT nil rate band. Again, accurate records are essential.

Conclusion

The residential nil rate band is a valuable but complex relief. Everyone’s circumstances and objectives are unique and if and how you use the RNRB will differ from individual to individual.

Planning and good record keeping is at the heart of maximising its advantages, as is independent financial advice.

Checklist

• Review your Wills
• Keep accurate records
• Consider gifts to individuals
• Consider creating Trusts in your lifetime
• Change your investments strategy to include IHT efficient investments

For further help and advice regarding reducing your Inheritance Tax Bill, please call us on 01244 347583 or email us at: info@innesreid.co.uk. 

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