Residence Nil Rate Band Guide

When it comes to inheritance tax, the residence nil rate band can be one of the best ways to minimise the amount of tax payable and maximise the value of an estate on death.

In this guide, we explain what the residence nil rate band is, how it works in practice, how an estate qualifies and how this relief can be claimed. We also look at the residence nil rate band rules relating to any unused allowance and what happens to this.

 

What is the residence nil rate band?

 

The residence nil rate band (RNRB) is a tax-free allowance for residential property owners that can be offset against any inheritance tax (IHT) payable on their estate after they die. This means that where someone dies, their estate must be worth more than the basic IHT and RNRB thresholds combined before any inheritance tax falls due.

Introduced in the tax year 2017/18, the RNRB was initially set at £100,000 but has been gradually phased in since then, increasing to £125,000 for the tax year 2018/19, increasing again to £150,000 for 2019/20, and increasing most recently to £175,000 for the years 2020/21, 2021/22 and 2022/23. It will remain fixed at this rate until 2026. The RNRB is essentially an additional amount that can pass on death without any IHT being payable, representing an ideal way of legally reducing liability to inheritance tax for loved ones.

 

How does the residence nil rate band work?

 

In the UK, inheritance tax is payable on a deceased’s estate, typically at a rate of 40%, on anything over and above a threshold of £325,000. This threshold is commonly referred to as the IHT basic nil rate band and has remained frozen at this level for more than a decade. This means that where the net value of the deceased’s estate falls below this amount, the beneficiaries under any will, or the rules of intestacy, will not incur any tax liability.

However, even where the net value of an estate exceeds this threshold, any additional amount can potentially be reduced by applying the residence nil rate band, increasing the overall amount that a person can leave to a loved one on death tax-free. This means that applying both the IHT basic nil rate band of £325,000 plus the residence nil rate band of £175,000, a person can pass on as much as £500,000 without their estate incurring any inheritance tax liability whatsoever.

The RNRB threshold, or even a combined threshold, does not necessarily mean that the deceased’s home will be exempt from inheritance tax but, depending on its value, this can be the result in some cases. Under the RNRB rules, the property inherited does not have to be worth more than the threshold to benefit from the residence nil rate band. Even if a property is worth more than the threshold, the rules make it easier for people to pass on the family home without loved ones facing a huge tax bill or being forced to sell up.

 

How does an estate qualify for the residence nil rate band?

 

A claim can be made for the residence nil rate band against the estate of someone who has died, provided the following two conditions are met:

• the estate includes a residence that was owned by the deceased, and
• the residence in the estate is inherited by the direct or lineal descendants of the deceased.

 

Residence owned by the deceased

To be eligible for the RNRB, immediately prior to the person’s death, their estate must include a ‘qualifying residential interest’. This refers to a residential property that the deceased owned and lived in as their home while it was included in their estate. This means that it does not need to be the deceased’s main home, or even have been lived in or owned for a minimum period of time. The person also does not need to be living in the property at the time of death, although it must be a property that at some point during their lifetime they used as a residence. In contrast, a property that the deceased owned, but never lived in, such as a buy-to-let property, is not a residence and will not qualify for the RNRB.

The RNRB can also apply if the deceased downsized to a less valuable residence at some stage in their life, or they sold or gave away a residence. In order to claim the downsizing allowance the deceased must have disposed of a former residence and either downsized to a less valuable property, or ceased to own any property, on or after 8 July 2015. In addition, the former residence must have qualified for the RNRB if it had been kept until death and at least some of the estate must be inherited by the deceased’s direct descendants.

 

Inherited by direct descendants

In addition to the deceased’s estate including a qualifying residential interest, the property in question must be also be ‘closely inherited’ for the estate to benefit from the RNRB. This means that the property, or a share of it, must be passed to a direct descendant, such as the deceased’s children, grandchildren or even their great grandchildren.

For the purposes of RNRB a ‘child’ includes an adopted or foster child or, if the deceased was either an appointed guardian or special guardian for a child who was under 18 at that time, the child will be treated as a child of the deceased. It also includes the deceased’s step-child, where a ‘child’ does not have to be under 18 at the deceased’s date of death, although a ‘step-child’ is limited to someone whose parent is, or their parent was, the spouse or civil partner of the deceased.

The RNRB rules also apply to the spouse or civil partner of a direct descendant, including the widow(er) or the surviving civil partner of a child, grandchild or great grandchild, provided that the widow(er) or civil partner had not remarried or entered into a new civil partnership before the deceased’s date of death. However, the rules do not apply to lineal ancestors, such as parents or grandparents, nor to siblings, nephews or nieces.

Importantly, provided a residence is left to direct descendants, it does not matter how the they inherit that property. The deceased’s home, for example, could be left to adult children as a specific legacy in a last Will and Testament, or it could be included in what is left of the estate after specific legacies have been taken into account, where the home does not have to be expressly mentioned in the testator’s Will. It can also include where a person dies intestate, but direct descendants inherit under the intestacy rules.

 

How is the residence nil rate band claimed?

 

To claim the residence nil rate band, details of the amount to be used and any supporting information should be given on the IHT400 account form and form IHT435. If there was more than one residence in the deceased’s estate, only one of these residences can be taken into account, but the executors or personal representatives of the deceased’s estate can nominate which residence they wish to be taken into account on the relevant form.

The executives or personal representatives will also need to include the value of the deceased’s interest in the residence, deducting any mortgage(s)or other debts charged on the property from the gross value and including the net value in the relevant box. This will represent the value of the residence that RNRB can be claimed on. For a residence left to people who are a mixture of direct descendants and others, the value of the home must be shared in proportion to the share of the property each direct descendant inherits. For example, if the property is worth £500,000 and half passes to the deceased’s son and half to a nephew, the figure to include here would be £250,000 for the share to the son only.

The RNRB is not an exemption or form of tax relief on the value of the property itself, rather it will be set off against the entire taxable estate, so the whole estate shares the benefit of the tax-free allowance. This can be used to work out how much relief an estate may get under the RNRB rules, as well as the relief if a person downsized or sold their home. However, the value of the deceased’s estate, including all money, possessions and property, will first need to be worked out before using the online calculator.

Importantly, however, when assessing inheritance tax on property for estates with a net value of more than £2million, there is a tapered withdrawal of the residence nil rate band. This means that the amount of available relief is reduced by £1 for every £2 of value by which the estate exceeds the tapered threshold. As such, by the time an estate reaches £2.35million or more, it will no longer benefit under the RNIB rules.

 

What happens to unused residence nil rate band?

 

If the value of the nominated property is worth less than the RNRB threshold, even though the residence nil rate band will be offset against the whole estate and not just the value of the home, any unused amount cannot be applied in respect of other assets within the estate. However, any unused amount would be available to transfer to the estate of any surviving spouse or civil partner when they die and leave a home to direct descendants.

In many cases, when someone dies, they will pass all of their money, possessions and property to their spouse or civil partner. By law, for those who are married or in a civil partnership, they can pass their whole estate in this way entirely tax-free, without any need to apply the IHT nil rate band or the residence nil rate band. This is because spouses and civil partners are classed as exempt beneficiaries for the purposes of inheritance tax.

The law also provides that any unused amount from the estate of a pre-deceased spouse or civil partner of the deceased can be transferred. This is known as the transferable residence nil rate band (TRNRB). The net effect of the TRNRB rules is to double the amount of money that a surviving spouse or civil partner can leave behind tax-free on their own death to their children, grandchildren or great grandchildren, totalling up to £1 million tax-free where qualifying residential property forms part of their estate.

For example, a man dies in the tax year 2020/21 leaving an apartment worth £100,000 and other assets worth £400,000 to his daughter, where the remainder of his assets, valued at £500,000, are left to his wife. The maximum available RNRB for that year is £175,000. However, the value of the taxable estate is only £500,000, as the £500,000 left to the wife is exempt. Having deducted £100,000 RNRB (the lower of £100,000 and £175,000) minus the IHT basic threshold of £325,000, this will leave £75,000 on which to pay inheritance tax at 40%. As the maximum possible RNRB for this estate was £175,000, but the flat left to the daughter is only worth £100,000, this means that only £100,000 of the tax-free residence allowance applies. However, the unused £75,000 RNRB is available to transfer to the wife’s estate.

The RNRB online calculator can be used to calculate any unused allowances for transfer to the estate of a surviving spouse or civil partner. However, the RNRB should always be applied before the basic nil rate band and any TNRB applicable when the death occurred. Usually, the order that the RNRB and basic nil rate band are applied will make no difference but, in some cases, the order can affect the amount of any unused additional or basic threshold available to transfer to a spouse or civil partner’s estate for when they die.

For unmarried couples, they individually qualify for the residence nil-rate band, but they will not be eligible to use any unused allowances from a pre-deceased partner.