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Explaining the Inheritance Tax Residenial Nil Rate Band

Article explaining the Inheritance Tax Nil rate band and how it may benefit you.

Leaf Financial Advisers - Bristol based Independent Financial Advisers

The residence nil-rate band

In 2015 the government introduced a new inheritance tax allowance, the Residential Nil Rate Band.  

Main facts about the Residential Nil Rate Band:

  • The residence nil-rate band applies to the estates of people who die after 6 April 2017.
  • You must be leaving a home to your children or grandchildren.
  • The allowance was phased in and it reached the maximum of £175,000 per person for deaths that occur after 6 April 2020 (so £350,000 per couple).
  • Adding this to a couple’s nil-rate band equals a potential £1 million per couple.
  • It is currently frozen until 2026.

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Why was the residence nil rate band bought in?

The new rules around the residential nil rate band were bought in as Inheritance tax was becoming an increasing problem for UK homeowners.

Due to many years and decades of increasing house prices, more and more people are now facing an inheritance tax liability on their estate, due to the increase in the value of their home. This issue is exacerbated by the current nil-rate band of £325,000 for inheritance tax being frozen and it is set to remain there until April 2026 as part of the Chancellor’s freeze on allowance.

In 2015, acknowledging the inheritance tax problem faced by an increasingly large number of homeowners, the Government introduced an additional inheritance tax allowance of up to £175,000 to apply to the family home under certain circumstances.

Although it should be noted that even with this new band being bought in, forecasts show that HMRC’s inheritance tax receipts are expected to continue to rise.

Who can claim the residence nil rate band?

Who can claim the residence nil rate band?

So who can claim the new allowance?  The intention of the new band is so that married couples and civil partners can pass on assets worth £1 million, including the family home, without paying any inheritance tax at all.

However, not everyone will benefit, and there are a few rules to be aware of:

  • As the name suggests, the property in question must have been the residence of the person who has died.
  • Only a maximum value of £175k per person is allowed, so any house value over that amount will not be included in the residential nil rate band (but can still be included in the general £325k band).
  • It will only apply if the property is being left to the deceased person’s direct descendants, which in this case are children or grandchildren.
  • For property worth over £2m, the residence nil-rate band will be reduced by a rate of £1 for every £2 by which the estate exceeds £2 million. This means that larger estates may not benefit as much or at all.

Who isn't eligible for the residence nil rate band?

The Residency nil rate band is not available to all.  The main exceptions are:

  • It won’t help you if you don’t own a property or have a property that is not your residence (e.g. a BTL).
  • If you do not have direct descendants or wish to leave your home to someone other than a direct descendant, you cannot benefit.
  • Anyone without a property worth at least £175,000 per person, or £350,000 per couple, will only partially benefit (as these are currently the threshold maximums)
  • Anyone who disposed of their property before 8 July 2015 – for example, because they are now living with children or in residential care – will not benefit from the new allowance at all.

Spousal Transfers and the residence nil rate band?

So what is a Spousal Transfer when it comes to Inheritance Tax?

Everyone has the same basic tax-free allowance before they must pay Inheritance Tax.  The current threshold is £325,000. If the threshold has not been fully used when the first person in a marriage or civil partnership dies, then it can be transferred, with the unused part going to the surviving spouse or civil partner.

How this works with the standard nil-rate band, is that when the first spouse or civil partner passes away and leaves their entire taxable estate to their surviving partner, then the estate of the second spouse can claim a total nil-rate band of £650,000 – double the individual nil-rate band.

In a similar way, the estate of the second spouse or civil partner to pass away will be entitled to claim double the residence nil-rate band applicable in the year of the second death, where their partner’s estate did not make such a claim. The maximum amount of the claim will still be limited to the greater of the allowance at the time of the second death, and the value of the home owned by the deceased.

It’s important to be clear when and how the threshold can be transferred, as there are many references to couples automatically being able “to claim £1 million of inheritance tax exemption”.  Yet to claim the full £1m the following criteria have to be met:

  • One spouse must pass away after 6 April 2020, when the £1 million maximum is reached.
  • The surviving partner must own a home worth more than £350,000 when they die themselves.
  • They must leave that home to their direct descendants (children or grandchildren ).
  • The total estate must be worth less than £2 million.

What is the current nil rate band?

Back in the 2019/20 tax year, the Residential Nil Rate Band was £150,000.  In the 2020/21 tax year this was increased to £175,000 and has remained at this level ever since with a freeze currently in place until 5 April 2026.

You may actually have a smaller nil rate band on your death than the threshold discussed.  Mainly if you made gifts during your lifetime that weren’t covered by your tax-free gift allowances and you die within seven years of making the gifts. The value of these gifts will reduce your nil rate band (potentially to zero), meaning more of your estate will be liable for Inheritance Tax.

Can you inherit the nil rate band?

As discussed above, for IHT purposes inter-spouse transfers are “exempt” transfers and thus not subject to IHT if the spouses are married. As above, transfers from one spouse to the other to ensure each spouse’s estate is at least £325,000 can therefore be made without being liable for any inheritance tax charges.

However, this is the only instance where the residency nil rate band can be passed on.  If a house is inherited then the nil rate band (or any remaining) is not passed down with the property, as is sometimes thought. IHT is levied on a person and their estate and dies with them, apart from the potential spousal transfer. 

Final Thoughts on the Inheritance Tax Residence Nil Rate Band

The Inheritance Tax Residential Nil Rate Band can be very useful when it comes to reducing your inheritance tax liability and forms an important part of wider financial planning around your retirement and later life plans.

If you would like to know more then please get in touch, we are regulated independent financial advisers and are happy to answer any financial planning questions you may have.