For financial advisers - compiled by our team of experts, qualified in pensions, taxation, trusts and wealth transfer.
A combination of rising property prices and frozen IHT nil rates bands will see an increase in the number of estates paying IHT over the next few years.
Latest figures from the ONS* show that house prices across the UK rose by 10% over the previous 12 month period. That's the highest rate of increase since before the 2008 banking crisis. And at the same time, both the standard and residence nil rate bands will remain fixed until April 2026.
The residence nil rate band (RNRB) is complex and often poorly understood. The OTS found in their review of IHT that some solicitors were even choosing not to advise clients on it because it was so complicated. But that could mean a married couple potentially paying an additional £140,000 in IHT unnecessarily.
So what are the areas causing the most confusion when it comes to meeting the RNRB conditions?
The RNRB can only be claimed when an individual dies and a direct descendant inherits the 'home' in accordance with the will, or under the intestacy rules. Broadly, a direct descendant is a child or grandchild of the deceased, but includes stepchildren and adopted children and anyone married to (or in civil partnership with) this group.
Someone's stepchild is a child that was born to their husband or wife during a previous relationship. A child will still be regarded as a stepchild in these circumstances even if they're an adult.
However, unmarried couples could potentially miss out on the RNRB. A partner's children from an earlier relationship won't be treated as stepchildren and therefore they're not a qualifying beneficiaries unless they have been legally adopted.
For deaths after 5 April 2020, the full RNRB is £175,000 per individual. In addition to this, the executors of the deceased can also claim the unused part from a spouse or civil partner who died earlier. The date the first spouse/civil partner died does not matter, even if this was before the RNRB was introduced in April 2017. Neither did the first to die need to own any part of the qualifying property.
However, the unused part from a deceased unmarried partner cannot be transferred, even if the couple had children together. A couple in this situation may therefore have to make a gift of qualifying property on first death in order to benefit from two lots of RNRB.
Unless the couple each own a property that was once their home, this could have its problems. If they jointly own the family home as tenants in common, the first to die could leave their share to their children and claim the RNRB, but this may lead to an uncertain future for the surviving partner who may wish to continue to live in the family home while only owning half of it.
If the survivor either inherits the home under a joint tenancy arrangement, or under the will of their partner, one RNRB may be lost.
Another aspect that affects the amount of RNRB that can be claimed is the value of the deceased's estate. Wealthy individuals who die with an estate of more than £2,000,000 (the taper threshold) may lose some or all of their RNRB.
However, confusion arises because the value of the estate assessed against the taper threshold is different from the estate subject to inheritance tax.
For the purposes of the RNRB and tapering, the 'estate' is broadly the value everything deceased actually owned when they died, after liabilities, but before taking into account any exemptions or reliefs. So this means:
There is therefore an opportunity for 'deathbed' planning where a lifetime gift is made to reinstate some or all of the RNRB, even if this gift is to the surviving spouse.
Post retirement it is not uncommon for people to sell the family home and move into a smaller home, whether for financial reasons or just for an easier lifestyle. Others may gift their home or sell up completely and either move in with family or move into care.
Provided the sale or gift of the house was completed after 7 July 2015, a 'downsizing addition' may be available to make up for the lost RNRB.
While the formula to calculate this is complicated, the outcome for many will be that they are still entitled to an amount equal to the full RNRB at the time of their death providing the value of the home disposed of was greater than the RNRB at the time of disposal.
Of course, where a downsizing addition is claimed, the property it's based on is no longer owned at death. An amount equal to the lost RNRB must therefore be left to direct descendants to be able fully use up the downsizing addition.
For wealthier clients with estates over £2,000,000, the downsizing allowance will be tapered in a similar way to the RNRB.
Where the deceased had downsized more than once since 7 July 2015, the executors can choose which transaction they wish to base their calculations on. It doesn't have to be based on the most recent move.
A basic condition for the RNRB is that the property must pass to direct descendants on the death of the parent or grandparent. It is not available on any lifetime gifts of property to children or grandchildren. For example, an elderly homeowner may gift their property to their children to either move in with them or go into care. Such gifts would generally be potentially exempt transfers and provided they are survived by seven years they would escape IHT anyway.
Any downsizing addition can only be claimed on death but it cannot be retrospectively applied to any failed PETs. However, provided on death there is still enough in the estate going to the children or grandchildren, the downsizing addition may be applied to this. The problem lies in where the house was the main asset of the deceased and there is little else left in the estate passing on to the children. In this situation the downsizing allowance may be lost.
Apart from the downsizing provisions, the main conditions to qualify for the RNRB is that the house must form part of the deceased's estate, and the children/ grandchildren inherit the property through the deceased's will or under the intestacy rules. How they inherit is another area of confusion. In particular, advisers should note that:
Trusts may be used for several reasons in connection with the home. The types of trust involved can have an impact on the availability of the RNRB.
To retain the RNRB, the basic condition is that the property is part of the deceased's estate, and following death it becomes comprised in the estate of a qualifying beneficiary.
Where a parent wishes to leave their property on trust for their children because they are too young, or because they would rather not give them the property outright, the following trusts will ensure that the RNRB is retained:
This is because the value of the property held in any of these trusts will be comprised in the estate of the beneficiary.
Conversely, if the deceased had been uncertain over who should benefit and when, they may prefer to create a discretionary will trust. However, although the intended beneficiaries might be the children or grandchildren, the value of the property held in trust is not included in any of their estates and so the RNRB would not be available on this transaction.
This could be remedied provided an appointment is made from the trust to a direct descendant within two years of the settlor's death. The beneficiary would then be regarded as receiving the property directly from the settlor allowing the RNRB to be claimed.
IPDI trusts may also be used as a solution for 'blended' families. For example, a husband may give his wife a right to occupy his share of the property but upon her death the property passes to his children from a previous relationship.
The trust property would accordingly be included in the wife's estate for IHT, and on her death would become immediately part of the childrens' estates.
The RBRB would not be used on first death and the IPDI for the wife would allow the spouse exemption to be claimed. When the wife dies, although the property is now in her estate for IHT, her executors would be able to claim for two lots of RNRB, subject to any tapering, and the property will pass under the terms of the trust to her stepchildren.
Note that for an unmarried couple in a similar situation, this planning falls down from a tax perspective. On first death, the IPDI created for the surviving partner would be a chargeable transfer because there's no spouse exemption and the RNRB cannot be used. Also, on second death the executors cannot claim the unused RNRB of the first partner and if the property passes to the first partners' children from an earlier relationship, they won't qualify as they're not the stepchildren of the second partner.
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