How can the family home be efficient for inheritance tax?

Death and taxes, they say, are the only two certainties in life but that does not mean there is nothing that can be done to reduce tax payable on death.

Your home is probably the most valuable asset you will ever own, and therefore it can have a large bearing on your estate for inheritance tax (IHT). There are various allowances available and a number of ways to ensure that they will apply to your estate, so that you can pass on as much of your estate as possible to your loved ones.

We explain how IHT relates to the family home and some ways that can ensure you make the most of the allowances you have.

How does IHT work?

IHT is a tax on the value of your net estate on death and on lifetime in the years before death. It is charged at 40% on the value of anything above the threshold or Nil Rate Band (NRB).

Everyone has their own NRB which is currently £325,000. Since 2017, there is also a Residence Nil Rate Band (RNRB) which attaches to property left to direct descendants. For the tax year 2020/21, this stands at £175,000.

Gifts to a spouse, civil partner or charity are exempt from IHT so do not eat into either your NRB or RNRB.

If your spouse/civil partner has died before you, you can transfer the unused percentage of their allowances. That means that if a sole surviving spouse/civil partner can leave up to £1 million to their children before IHT becomes payable. The RNRB can therefore be crucial in allowing your children to inherit your home without being forced to sell it to pay tax.

Am I eligible for the RNRB?

Your estate must include a “qualifying residential interest” which is “closely inherited”.

A qualifying residential interest means a property (or a share in a property) that is your residence at some point during your period of ownership. If you own more than one residential property, your executors can nominate any one of them as your qualifying residential interest, provided that you lived there at some point while you owned it. It does not matter if you then move into a different property or into care, just as long as you still own it.

“Closely inherited” means that the qualifying residential interest has to be left to lineal descendants. This does not just mean your natural children. It also includes:

• All children, grandchildren and so on, whether they are natural, fostered or adopted

• Stepchildren, step-grandchildren,

• Spouses and civil partners of the above, including former spouses who have not since remarried.

You may not want to leave your property to them outright. It is possible to claim the RNRB by including certain kinds of trust in your Will, and our expert team will be happy to discuss this with you if you would like.

What if I downsize or sell completely?

You can still claim the RNRB if you sell your home and downsize to a less valuable property. You can also claim it if you do not buy a replacement property, such as if you move into a rental property or into care.

You would have to have sold your home on or after 8 July 2015 and at least part of your estate has to be closely inherited.

Do my children have to keep the property?

No. The RNRB does not attach to the bricks and mortar of the property, just to the fact that you have an interest in it. Your executors can either sell or transfer the property to your children, and your estate will still be eligible for the RNRB.

I’ve heard that you can’t claim the RNRB if the house is worth more than £2 million. Is that right?

Not entirely; The RNRB starts tapering away once your net estate, not just the value of your property, is over the taper threshold (currently £2 million). You can deduct liabilities from this, including any mortgage.

The amount of RNRB is reduced by £1 for every £2 that the net estate is over the taper threshold. That means that once your net estate is over £2,350,000 there is no RNRB available.

Can I do anything to get round the taper?

The key is to reduce the size of your estate so that it is under the taper threshold.

A simple way is to make gifts during your lifetime, which would reduce the size of your net estate. However, this may not always be possible, particularly if you do not have much cash or other liquid assets to live off. There is also the risk that you could die within 7 years of making a gift, in which case that gift would attract IHT and use up some of your nil rate band.

An alternative could be to include a Nil Rate Band Discretionary Trust in your Will. A discretionary trust works by naming a number of beneficiaries (such as your spouse, children and grandchildren) and allows your executors/trustees to give out the assets in the trust as they think fit.

On first death, not all of the estate would go straight to the survivor: some of it would be tied up in a trust. This means that on second death the value of the estate is lower than it otherwise would have been, while still allowing your spouse to be a beneficiary of the trust.

Of course, every client’s situation is different and a solution that works for one client will not necessarily work for another. Our team would be delighted to discuss your circumstances with you and work out a bespoke solution.

I’m divorced and my ex had children from a previous relationship. I want to leave my estate to them. Can I still get the RNRB?

In that case, you should still be able to claim the RNRB. For IHT purposes, it is a case of once a stepchild, always a stepchild; the fact that you divorced does not stop your ex’s children from being your stepchildren.

I’m not married but my partner has children from a previous marriage. Can I get the RNRB if I leave the house to them?

Not unless you marry your partner or go through the adoption process. A partner’s children only count as your stepchildren when you are married to your partner.

I am widowed and have remarried. Can I still claim my late spouse’s RNRB?

Yes, you can claim the unused percentage of both their NRB and RNRB. If you then leave your estate to your new spouse, they will be able to transfer any remaining NRB and RNRB that you still have. However, their transferrable allowance is capped at 100% of their own NRB and RNRB, i.e. the surviving spouse can only claim two NRBs and two RNRBs.

In this case it can be useful for your Wills to include a Nil Rate Band Discretionary Trust to ensure that all the NRBs and RNRBs are used up or transferred, with none going to waste.

At Taylor Rose, we have a strong Wills, Trusts & Probate team who specialise in Wills, tax and succession planning. We recognise that there is no ‘one size fits all’ approach, particularly as alternatives to the traditional ‘nuclear family’ become more and more commonplace. Our team of dedicated lawyers will be more than happy to discuss your circumstances and work towards a solution that is tailor-made for you.

If you would like to discuss tax planning with us, call us on 020 3540 4444, email us at info@taylor-rose.co.uk or contact us to request a call back, and one of our expert team will be happy to discuss how we can help.