On 6th April 2017 significant inheritance tax changes were introduced, providing additional relief for married couples, civil partners and even individuals. As such, when we pass away, we can now leave more than ever tax-free to our loved ones.
Inheritance tax changes for residential property
As the law currently stands we are all entitled to an inheritance tax allowance of £325,000. This is known as the inheritance tax nil-rate band. When we die, anything over and above this amount is liable to inheritance tax, generally at a rate of 40%.
However, the net effect is that you are able to pass on up to £325,000 tax-free.
While the existing nil-rate band has been frozen until 2020-2021, recent inheritance tax changes mean that the amount you are able to pass on tax-free has increased significantly by way of a new residence nil-rate band.
Given the number of homeowners in the UK, this new property relief will be of real benefit to many of us, enabling us to reduce even further the inheritance tax burden for our children and grandchildren.
The new residence nil-rate band
The new inheritance tax changes are being gradually phased in. Since the introduction of the residence nil-rate band in 2017 the maximum amounts available are as follows:
• £100,000 (2017-18)
• £125,000 (2018-19)
• £150,000 (2019-20)
• £175,000 (2020-21)
By 2020, assuming the qualifying conditions are met, an individual will be able to pass on as much as £500,000 without their estate incurring any inheritance tax liability.
This is taking the standard nil-rate band of £325,000, together with the maximum residence nil-rate band of £175,00.
After 2021, the threshold is likely to increase annually in line with inflation.
For those of you with estates with a net value of more than £2million there is a tapered withdrawal of the residence nil-rate band. Here the amount of available relief will be reduced by £1 for every £2 of value by which the estate exceeds the tapered threshold.
Qualifying for the residence nil-rate band
To qualify for the new residence nil-rate band your estate must include a qualifying residential interest immediately prior to your death.
You do not need to be living in the property at that time, but you do need to have used the property as a residence at some point during your lifetime.
Further, for the estate to benefit from the new inheritance tax changes, the qualifying property must also be inherited by a direct descendant, namely a child or grandchild, or their spouse or civil partner.
The new residence nil-rate band does not, however, benefit lineal ancestors such as parents or grandparents, nor siblings, nieces or nephews.
Calculating the residence nil-rate band
Inheritance tax is paid on your estate after you die. Your estate comprises any money, property and possessions once funeral expenses, administration costs, debts and liabilities have been paid.
Any inheritance tax liability will be assessed on the basis of the net value of your estate, having taking into account any available exemptions or property relief.
However, the residence nil-rate band is not an exemption or relief on residential property itself, rather it is set off against the entire estate of the deceased.
The amount of the residence nil-rate band due for an estate will be the lower of:
- the value of the home, or the share that is passed to any direct descendants, or
- the maximum additional threshold available for the estate when the person died.
The rules on downsizing before you die
As we get older, it is not uncommon for many of us to want to downsize the family home or even sell up. It may be that we can no longer cope with the upkeep of a larger property, or that we are unable to live unassisted and need to fund care fees.
Luckily, there are downsizing provisions included in the latest inheritance tax changes to help ensure that direct descendants will still benefit from some or all of the new residence nil-rate band where you have recently sold or downsized your home.
The rules provide that where a person dies after 5 April 2017 and has disposed of or downsized their residence on or after 8 July 2015, the downsizing provisions may apply.
In broad terms, the rules provide that if both the downsized residence and other assets in the estate are inherited by direct descendants, the estate will still qualify for an additional amount of property relief.
This will be broadly equal to the lower of the amount of the residence nil-rate band and the value of the other assets inherited by the children or grandchildren.
However, the rules can become quite complicated depending on whether you have sold your home and bought a smaller residence, or disposed of your residence without acquiring an alternative property.
Inheritance tax changes for married couples
If you are married or in a civil partnership you are allowed to pass your money, possessions and property to each other entirely tax-free.
Furthermore, the nil-rate band is transferable as between spouses. In other words, where one spouse or civil partner passes away and any part of the nil-rate band remains unused, this can be added to the allowance of the other.
Following recent inheritance tax changes this also includes the residence nil-rate band.
Consequently, by 2020, married couples and civil partners will be able to pass on up to £1 million tax-free to their children and grandchildren where a qualifying residential interest forms part of their estate.
Unfortunately, these rules do not currently apply to unmarried couples, although a potentially imminent government shake-up of the entire inheritance tax system may lead to further changes.
Inheritance tax changes for lifetime gifts
As it currently stands you can make tax-free gifts during your lifetime to your spouse or civil partner, or to charity, but there are strict rules preventing you from gifting large chunks of your estate to your direct descendants.
The annual gift exemption stands at just £3,000.
In broad terms, any gifts that you make within seven years of your death over and above the annual gift exemption may still be liable for inheritance tax, albeit on a sliding scale.
The amount of taper relief increases with the number of calendar years between the date of the gift and the date of death. This can be as little as 8% where the gift is made between 6-7 years, but as much as 32% where the gift is made between 3-4 years of the date of death.
That said, the rather complex rules relating to PETs are currently under review by the Independent Office of Tax Simplification, so further inheritance changes may again be imminent.
In particular, the annual gift exemption has stood at the same rate of £3,000 for over 30 years. Although it is widely anticipated that this may be increased, any further changes are yet to be announced.
Key takeaway for inheritance tax changes
The rules relating to the latest inheritance tax changes can be complex, not least those relating to the new residence nil-rate band and the downsizing provisions.
That said, these changes will potentially bring about a significant increase in tax benefits for your loved ones after you die and so, despite their complexity, they still provide welcome financial relief for many of us.
And with any luck, additional beneficial inheritance tax changes are soon to follow.