Finance Act: How will property nil rate band work in practice?

Last year the government announced measures designed to tackle the growing number of estates drawn into an inheritance tax liability as a consequence of house price appreciation.

The residence nil rate band (RNRB) will eventually allow up to £175,000 of property wealth, per person, to be passed on with no IHT liability. Added to the standard nil rate band of £325,000, a couple can expect to pass on £1m free of IHT.

The allowance only relates to the primary residence of the individual who dies on or after 6 April 2017. However, it is fully or partially transferable on first death of a spouse or civil partner in the same way as the standard NRB, provided it is available.

The RNRB will be phased in, reaching £175,000 in the ‘20-21 tax year (see below) and applies to residences sold on or after 8 July 2015. This is referred to as the ‘residential enhancement’.

  • 2017-18  £100,000
  • 2018-19  £125,000
  • 2019-20  £150,000
  • 2020-21  £175,000

Thereafter it is expected that the RNRB will increase in line with the consumer prices index measure of inflation.

While the new allowance was introduced in principle in last summer’s Budget following the Conservative’s general election victory, the small print behind the rules was not clarified until the December Finance Bill.

The Bill outlines how the RNRB will operate where a property sale (e.g., downsizing in retirement) might deny the opportunity to take advantage of the additional allowance.

Broadly speaking, the RNRB will still be available where a sale or downsizing means that equity unlocked in a property might otherwise be ‘lost’ from the allowance. Providing certain conditions are met, the estate will still benefit from the maximum RNRB as if the individual had died while in ownership of the original property.

Where a downsizing occurs, how will the allowance be calculated in practice?

The downsizing addition is calculated in percentage terms with the percentage of RNRB lost due to the sale of the property or downsizing which is then added to the person's residential enhancement and any unused allowance brought forward from a deceased spouse or civil partner.

The process is as follows:

  • Calculate the percentage of then available RNRB had the individual died with the former residence under their ownership, i.e. if the transaction had never happened.
  • Calculate the percentage of the currently available RNRB that the individual can claim based on property owned on death.
  • The difference between these two percentages is multiplied by the RNRB that the individual is otherwise able to claim on death.
  • Add this amount to the person's residential enhancement and any unused allowance brought forward from a deceased spouse or civil partner.

Example 1:

Let us assume that individual A sells a property for £250,000 in 2020 and moves into residential accommodation.

Their RNRB is calculated as follows. £250,000 property value/£175,000 available RNRB at time of sale = 1.42. The sale of the property is 142% of the residence nil rate band. They are therefore treated as having entitlement to 100% of the available RNRB when they eventually die.

On death, the full £175,000 RNRB is added to the £325,000 NRB entitlement, giving individual a total allowance for IHT purposes of £500,000. 

Example 2:

Individual B sells a home in 2020 for £500,000 and buys another for £150,000. They have a deceased spouse and a total RNRB entitlement of £350,000. When B dies, the new property is worth £170,000.

By downsizing, B has potentially lost the opportunity to use £180,000 (51.43%) of the RNRB.

The calculations are as follows:

£500,000/£350,000 -= 142%. This is to be treated as 100% of the RNRB available on death.

£170,000/£350,000 = 49%

£180,000/£350,000 = 51.43% multiplied by £350,000 = £180,000

B has 100% of the RNRB available so the estate can therefore claim up to £350,000 RNRB.

The £180,000 ‘lost’ RNRB is then added to £170,000, the value of the new property on B’s death (£350,000) which falls within the available RNRB.

If the total amount exceeded the available amount of RNRB, the amount that could be claimed will be capped at the amount of available RNRB.

There are a number of other factors for clients to be aware of, however.

Where the main residence is downsized to a lower value property or sold so that the full RNRB can no longer be claimed, the new property or an interest in the property or other assets must be left to direct descendants on death in order for the allowance to apply.

If no assets whatsoever are passed to direct descendants, the estate will not qualify for an additional allowance under the RNRB.

It is not necessary for the new residence itself to be inherited by direct descendants. The property can be left to someone else. However, at least some assets must be passed to direct descendants. The additional allowance will then be limited to the lower of the amount of RNRB lost as a result of the downsizing or the value of the property or other assets being inherited by descendants.

For example, on a £1m estate, if assets totaling only £100,000 are passed to direct descendants, only £100,000 of the RNRB can be added to the NRB. This would give a total IHT-free amount of £750,000 (assuming the full £650,000 NRB allowance is available).

The sale must also have occurred on or after July 8 2015, the date on which the proposals were first announced. Transactions that took place prior to this date are not eligible for a RNRB allowance. Only properties owned prior to this date can qualify.

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