From April 2017 a new residence tax free allowance is being introduced for Inheritance Tax purposes. How will this affect you?

At present Inheritance tax is payable at the rate of 40% on the value of the estate over and above the tax-free allowance (known as the ‘nil rate band’) of £325,000 per person. Married couples and registered civil partners can pass any of the unused allowance onto each other, effectively resulting in a maximum allowance of £650,000 between them.

In relation to deaths after 5th April 2017, if an individual’s estate includes a “qualifying residential interest” which has been his/her residence and which goes wholly or in part to descendants, the current nil rate band is subject to an enhancement. The enhancement is reduced for large estates. This enhancement, to the extent that it is unused on the first death is also transferable to the surviving spouse or civil partner. A claim must be made within two years of death.

In effect, the deceased’s estate must include an interest (usually ownership, but a liferent interest is also included) in a dwelling house which has been his/her residence. It does not need to be the main residence, the residence for any minimum period, the residence at the date of death or even situated in the UK. If there is more than one such dwelling house at the date of death, an election can be made for one to be treated as the qualifying residence.

The dwelling house must be transferred on death, to descendants of the deceased. As expected this includes children and grandchildren of the deceased. Also included are step-children, adopted children, foster children and any minors (under the age of 18) if the deceased is the minor’s guardian. Any descendants of individuals in this list are included. Also included are spouses or civil partners of lineal descendants. However if the lineal descendant has predeceased the deceased and their spouse or civil partner has remarried, they are no longer included.

The dwelling house must be inherited by one or more of the individuals listed either in terms of the deceased’s Will or under intestacy. If the property is inherited by way of Deed of Variation or by survivorship destination then this would also be included. The beneficiary does not need to live in the dwelling house and they can sell it following the death.

It should be noted that transferring the property into a discretionary trust on the deceased’s death, even if some of the beneficiaries of the trust are descendants, would not qualify. If your Will currently includes a discretionary trust, you may wish to consider why this was put in place and whether it is still relevant for your personal circumstances.

An individual’s nil rate band is increased by the “residential enhancement”. The maximum additions are as follows: £100,000 in 2017-2018, £125,000 in 2018-2019, £150,000 in 2019-2020 and £175,000 in 2020-2021. By 2020-2021 for a couple, the combined maximum nil rate band (£650,000) plus both residential enhancements (£350,000) will reach £1 million.

The residential enhancement will be reduced by £1 for every £2 by which the estate is over £2 million. If you are lucky enough that your estate (or your combined estate for spouses or civil partners) is likely to be in excess of £2 million then careful inheritance tax planning should be considered to prevent the residential enhancement being tapered away to nothing.

As with the current nil rate band, if the first of a married couple or civil partnership to die does not use all of his or her nil rate band, the percentage unused can be transferred to the survivor. The unused allowance can be transferred even if there is no home in the estate of the first to die. It does not matter when the first spouse or civil partner died, provided the surviving spouse or civil partner dies on or after 6th April 2017.

The new provisions also cover the scenario where a person wishes to downsize to a smaller property or sell their house to move into residential care. Therefore if the deceased formerly owned a qualifying residential interest which he/she has disposed of during their lifetime and has left other assets to descendants on death, there may be a downsizing addition to the nil rate band available on death.

Should you wish to obtain more information on the new residence nil rate band or should you wish to make a Will or review your current Will, please contact our Forbes McLennan or our Vivienne Bruce (This email address is being protected from spambots. You need JavaScript enabled to view it.) by email or by telephone on 01224 581581.