The ‘residence nil rate band’ (RNRB) was introduced with effect from 6 April 2017. The RNRB, which is designed to protect the family home from inheritance tax (IHT), was £100,000 for deaths occurring in tax year 2016/17 and has been phased in gradually over four tax years at a rate of £25,000 per annum until it reached £175,000 in tax year 2020/21.
Like the standard nil rate band of £325,000, the RNRB is transferable between spouses/civil partners to the extent it is not used on the first death. This means that where none of the standard rate band or RNRB is used on the first death, and the second death occurs on or after 6 April 2020, married couples/civil partners with a main residence worth at least £350,000 will be able to leave a total estate of £1m to children/grandchildren before any IHT is payable. This will have a significant impact on IHT planning strategies for anyone with children and an estate in excess of £325,000 (or £650,000 in the case of a married couple/civil partners) who will undoubtedly want to structure their affairs to make the most of this important opportunity.
The RNRB has been phased in gradually between 6 April 2017 and 6 April 2020 on the following basis:
For deaths occurring on or after 6 April 2017, the RNRB will take precedence over the standard nil rate band. However, unlike the standard nil rate band, which is available to everyone regardless of the composition of their estate or how it is left, the RNRB will generally only be available to the extent that a ‘qualifying residential interest’ is ‘closely inherited’ (an exception is where the downsizing provisions apply – see below).
A qualifying residential interest (QRI) is broadly an interest in a residential property that has, at some point during the deceased’s period of ownership, been occupied by him/her as a residence. Buy-to let properties cannot therefore qualify as QRI’s although a property that was once occupied by the deceased as a residence, but has been subsequently let to tenants, can be. Holiday homes – whether in the UK or overseas – could also theoretically qualify as QRIs provided that they are within the scope of IHT and have been used as a residence from time to time by the deceased.
Where the deceased owned more than one QRI and both are given away on his/her death, the deceased’s personal representatives must nominate which one should be treated as the QRI. Clearly, they will need to make sure that the one they nominate is being closely inherited.
A QRI will be ‘closely inherited’ if, on the death of the person who owns it (or is deemed to own it for IHT purposes), it passes to any one or more of:
For these purposes, ‘children’ is given a wider meaning than usual and includes adopted, fostered and step-children; any children for whom the deceased acted as guardian while they were under 18; and the children/grandchildren of all such children.
In some cases, property settled in trust on death for persons falling within one of the above categories will also be treated as having been closely inherited (see ‘The RNRB and trusts’ below). Notably, however, a property that is left to a spouse/civil partner or to an unmarried partner will not be deemed to have been closely inherited.
Where RNRB is available, it is offset against the value of the estate passing on death and is restricted to the value of the QRI or, if lower, the amount of the QRI that is closely inherited.
Example – Ted
Ted has an estate worth £600,000 including a property valued at £250,000. He dies in August 2020 (when the RNRB is £175,000), leaving a 50% share in his house to Irene (his long-term, live-in partner) and the remaining 50% to his children from his first marriage. Ted’s estate will benefit from £125,000 of RNRB. This is because the RNRB is limited to the value of the QRI that is closely inherited. Ted’s estate would, of course, also benefit from the standard nil rate band of £325,000.
Like the standard nil rate band, if the RNRB is not used on the first death of a married couple/civil partners, it can be carried forward to be used on the second death. Provided the second death occurs on or after 6 April 2017, it does not matter how long ago the first death occurred.
The amount available for carry forward must be calculated in percentage terms and applied as an uplift to the residence NRB amount available on the second death. Particular points worthy of note are that:
Example – Simon
Simon died prior to 6 April 2017 leaving his entire estate to his wife Susan. When Susan dies, in August 2020, her estate can therefore benefit from a 100% uplift to the basic RNRB amount of £175,000 that would otherwise be available. This means that the maximum RNRB available to Susan is £350,000. Provided, therefore, that Susan leaves a QRI of at least this amount to her children (or other direct descendants or their spouses/civil partners), her executors will be able to claim the full amount.
If the value of Susan’s QRI (or the part of it being closely inherited) is less than £350,000, Susan’s RNRB will be restricted to the lower amount (unless the downsizing provisions apply – see below). Susan’s estate can also benefit from an enhanced standard nil rate band of £650,000.
In this example, Simon leaves his entire estate to Susan, however, because Simon died prior to 6 April 2017 the RNRB result would have been the same (insofar as Susan benefits from a full transferable RNRB) even if he had left a part of the residence to children on his death (although of course, part of the standard nil rate band would then have been used on first death).
Where the first death occurs on or after 6 April 2017, the position will be based on the facts of what actually happened on the first death.
The available RNRB is reduced by £1 for every £2 by which the deceased’s net estate exceeds a certain threshold known as the taper threshold. The taper threshold is currently set at £2m initially and will increase in line with the CPI from 6 April 2021. “Net estate” for these purposes means everything to which the deceased is beneficially entitled after deducting liabilities such as loans but before deducting exemptions and reliefs such as business or agricultural property relief. This means that business and agricultural property is included at its full value – thereby precluding many farmers and business owners from benefiting from the RNRB altogether. Equally, the fact that property may pass to a charity and be exempt from IHT has no impact the value of the estate for taper purposes.
Tapering will also apply to reduce any transferable (or ‘brought forward’) RNRB where the estate of the first to die exceeds £2m; as well as to any addition given by reason of downsizing or disposal (see below). Consequently, if, in the case of married couples/civil partners, the estate on the second death is sufficiently large, both the RNRB of the survivor and any brought forward transferable amount could be lost altogether. This will be the case even if the estate on the first death was below the £2m taper threshold and/or the RNRB was not used.
Example – Gillian
Gillian, a widow (who has inherited her late husband’s entire estate of £1.25m) dies in July 2021 with an estate of £2.5m that includes a main residence worth £1.6m. Her estate would ordinarily benefit from:
However, as Gillian’s estate exceeds the £2m threshold by £500,000, the residence nil rate amount available will be reduced by £250,000 to £100,000. This means that even though her late husband’s estate was well within the taper threshold and he used no part of his own RNRB, his RNRB is effectively lost.
Her standard nil rate band is not affected by the value of her estate and the estate therefore benefits from a total nil rate band of £750,000 on her death.
The practical effect of taper is that for a single person who dies in 2020/21 tax year, the RNRB will be lost altogether where the estate exceeds £2.35m. For married couples/civil partners who are leaving everything to the spouse/civil partner on first death, the corresponding figure on the second death is £2.7m (tax year 2020/21).
Wealthy clients who would otherwise be able to benefit from RNRB may therefore want to consider taking steps to preserve entitlement to the RNRB. This could include:
For a married couple/civil partners with a joint estate of £2.8m, making a joint PET of £800,000 could provide a total IHT saving of £460,000 if they both survive the PET period (although capital gains tax considerations could of course apply).
It should be noted that the value of the deceased’s estate for the purposes of the RNRB taper threshold is the value immediately before the deceased’s death. It therefore takes no account of previous lifetime gifts – even if those gifts were made within the last seven years – and even if made a short time before death.
Example – Roger
Roger, a divorcee, owns a house worth £1.85m, a business property share portfolio worth £500,000 and investments of £150,000. He plans to leave all his estate to his adult children, Brad and Angelina. Currently, on Roger’s death, due to the impact of the taper rules all of the RNRB will be lost. By making a gift of the business property share portfolio – even a few weeks before death – his estate will qualify for a full RNRB. This could result in an IHT saving of as much as £70,000 now the RNRB is fully phased in.
Of course, death-bed planning should be viewed as a last resort – not least because there is no guarantee that the client would be mentally capable of making the gifts if planning was left to the last minute.
In certain circumstances, property settled in trust on death will also be deemed to have been closely inherited. Basically, this will be where the property is to be held either absolutely for the benefit of someone falling within the extended definition of a direct descendant; or on qualifying interest in possession trusts for such a person (in other words a trust where the ‘direct descendant’ has either an immediate post-death interest (IPDI) or a disabled person’s interest). Property will also be deemed to be closely inherited where it is left to a bereaved minors’ trust or an 18-25 trust where the beneficiaries will, by definition, be the children of the deceased.
It is important to note that property left to a discretionary trust can never be ‘closely inherited’ – even if all the beneficiaries of the trust are direct descendants. This can have implications for will drafting, and wills made before the changes were announced should therefore be reviewed to make sure that they remain tax-efficient. In particular:
In the 2018 Budget the Chancellor announced minor technical amendments to the definition of ‘inherited’ to ensure that where a residence forms part of a person’s estate immediately before their death as a gift with reservation (so for example where someone has made a gift of the property but have continued to live there rent free), it will only be treated as being inherited by a direct descendant if the property was immediately within the direct descendant’s estate following the original gift.
However, this change may not apply in many cases in practice. This is because for example, if the property is held in a discretionary trust and the donor is in rent-free occupation then this will be a gift with reservation. However, it will not immediately be in estate of the direct descendant following the original gift given the trust is discretionary. As such, it will not be treated as inherited by a direct descendant and thus the RNRB will not be available.
Those who downsize or dispose of their property before their death (for example, to move into residential care) will, in certain circumstances, be compensated for lost RNRB with a ‘downsizing addition’. The downsizing provisions are set out in Schedule 15, Finance Act 2016 and apply where a person who dies on or after 6 April 2017 has either disposed of their only residence on or after 8 July 2015 or downsized to a lower value property since that date and lost out on all or part of an RNRB as a result. In such cases, provided that there are other assets in the estate that are closely inherited, the estate will qualify for compensatory ‘additional’ nil rate band (ANRB).
The amount of the ANRB will generally be equal to the RNRB that has been lost as a result of the disposal, however, the position will not always be this straightforward as the amount deemed to have been lost must be calculated in percentage terms in accordance with a fairly involved formula.
Example – Jeremy
Jeremy, who is divorced, downsized from a large house worth £500,000 to a small flat in May 2019 when the RNRB was £150,000. He dies in September 2020, when the RNRB is £175,000, leaving the flat (worth £105,000) to his son, and the rest of his estate worth £50,000 to his two daughters. Jeremy’s estate will benefit from RNRB of £105,000 (as this is the value of the residence that is being closely inherited); plus ANRB calculated in accordance with the following steps:
1. Express value of former home as a percentage of RNRB at date of disposal (i.e. £500,000/£150,000) = 333%. Note that where this is more than 100% this is limited to 100%.
2. Express value of new residence as a percentage of RNRB at date of death (i.e. £105,000/£175,000) = 60%.
3. Calculate difference between percentages at steps 1 and 2 (i.e. 100% – 60%) = 40%.
4. Multiply RNRB at date of death by % at step 3 to give total lost RNRB (i.e. £175,000 x 40%) = £70,000.
Although the maximum ANRB available to Jeremy’s estate is £70,000, this is restricted to the value of other assets being closely inherited (i.e. £50,000). This means that Jeremy’s estate will benefit from RNRB of £105,000 and ANRB of £50,000, giving a total RNRB of £155,000. His estate will also, of course benefit from the standard nil rate band of £325,000.
The same principles apply where someone sells or otherwise disposes of their only residence prior to death.
Example – Daphne
Daphne, who has never married, gifts her home worth £400,000 to her daughter in May 2020 shortly after moving into residential care, thereby losing the benefit of a RNRB of £175,000.
If Daphne dies soon afterwards, the IHT position would be that:
As can be seen from these examples, a simple calculation of the difference between the amount that could have been claimed and the amount that can actually be claimed will often give the same result; however it is important to bear in mind that occasionally the full calculation can produce an unexpected result. This will most commonly happen where transferable or ‘brought forward’ RNRB has to be factored into the downsizing calculation.
Example – Hilary
Hilary sold her home for £285,000 in October 2019 to go into residential care. The maximum RNRB in the tax year 2019/20 was £150,000.
She dies in March 2021 when the maximum RNRB is £175,000. As Hilary inherited her husband’s entire estate on his death in September 2017, Hilary’s estate will be entitled to transferred or ‘brought forward’ RNRB.
In this situation, the ANRB will be equal to the difference between the RNRB that would have been available at the date of death if a house equivalent in value to the former residence formed part of the estate at that time, and the RNRB that is actually available at the date of death by virtue of the downsize. In other words, the RNRB to be used in Step 1 of the full calculation is the maximum RNRB that was in force at the date of the disposal plus the transferred RNRB to which the estate is actually entitled at the date of death. Putting the figures into the calculation will help illustrate this:
1. Express value of former home at date of disposal (i.e. £285,000) as a percentage of RNRB in force at date of disposal (i.e. £150,000) plus ‘brought forward’ RNRB that is actually available to Hilary’s estate at the time of her death (i.e. £175,000). So: £285,000/£325,000 = 88%.
2. Express value of new residence (as there is no new residence this will be £0) as a percentage of RNRB at date of death i.e. £0/£350,000 = 0%.
3. Difference between 0% and 88% = 88%.
4. 88% x RNRB available at date of death = 88% x £350,000 = £308,000.
As can be seen, where RNRB has been lost as a result of a disposal (so that there is no residence in the estate at the date of death), the full calculation is somewhat simplified because the percentage at step 2 will always be 0% and the result at step 3 will always be the same as the figure at step 1. This means that steps 2 and 3 can effectively be missed out and the percentage calculated at step 1 can simply be applied to the RNRB available at the date of death to find the ‘lost’ RNRB.
The ‘lost RNRB’ in this example is therefore £308,000, however, the actual amount of ANRB to be given is the lower of the value of other assets left to a direct descendant and the lost RNRB. Provided therefore that Hilary leaves other assets worth at least £308,000 to her children, her estate will benefit from an ANRB of that amount, otherwise it will be restricted accordingly. Of course, Hilary’s estate will also benefit from a standard nil rate band of £650,000 giving her a potential total NRB of £958,000
It is vitally important to remember that a lifetime gift of the main residence will only be compensated for with ANRB if both the new lower value property (if any) and other assets are closely inherited. Where there are no (or few) other assets in the estate, the RNRB will be lost altogether. A gift of the main residence in these circumstances could create an IHT liability where there would otherwise have been none.
For example, an individual who dies in the 2020/21 tax year with a main residence worth £500,000 and no other assets will have no IHT liability (provided that the house or a share of it to the value of £175,000 is closely inherited). However, if the house is gifted prior to death, IHT of £70,000 will be payable on the failed PET if death occurs within seven years – with no compensatory addition.
In the 2018 Budget the chancellor announced minor technical amendments to the RNRB rules on downsizing to ensure that the value of any part of a residence inherited by an exempt beneficiary, such as a surviving spouse inheriting a deceased spouse’s share of a property, will be taken into account when calculating the relief due under the downsizing provisions.
This change is simply bringing the downsizing relief into line with how one might expect the relief to operate.
Of course, whilst the RNRB will undoubtedly be useful to people with a potential IHT liability who are planning to leave a private residence to children or grandchildren, it is unlikely to mean the IHT liability disappears altogether and other planning will therefore frequently be necessary.
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