How does the new inheritance tax perk work?
As of 5th April 2017 new legislation offers further tax breaks for inheriting descendants, pushing a couple’s tax-free allowance up to £1m. But it’s not as simple as it seems. Deborah Adams, director of our private client team, explains what the RNRB means for tax and succession planning, lifetime gifts and properties over £2m. There’s also a handy calculation example for a farming family.
Until April 6, 2017, if you inherited a property worth more than £325,000 you would be hit by a huge inheritance tax bill. As a result of two decades of rampant price rises, that is happening to more and more families, something which the Conservative Government pledged to correct before the 2010 election. The new rules, which have finally come into force, add on an extra tax-free allowance of £100,000 this year, per person, which rises to £175,000 steadily over the next four years.
As an individual your IHT tax allowance will jump up to £500,000 (£325,000 + £175,000).
For a married couple or civil partnership, that means £1m tax-free allowance.
Sounds like good news all round? But the new rules are quite baffling. So, let’s deal with the things we know first.
NRB Vs RNRB
The inheritance tax (IHT) threshold of £325,000 is called the Nil Rate Band (NRB). The new legislation enhances that. The result is a new ‘home’ allowance — the Residence Nil Rate Band (RNRB) — which introduces an additional nil-rate band when your residence is passed on to a direct descendant after death.
The rules of the RNRB
Inheritance tax (IHT) needs to be paid on any estate (the property, money and possessions) of someone who has died. The standard IHT rate is 40%, but there’s usually no tax to pay if the value of your estate is below the £325,000 threshold (the NRB) or you leave everything to your spouse or civil partner, a charity or a community amateur sports club.
Your estate will be eligible for this extra allowance (on top of the NRB) if:
- you own a home, or a share of one, which is included in your estate
- your direct descendantsinherit the home (or a share of it)
- the value of your estate does not exceed £2million
- you die on or after April 6, 2017
While the standard NRB is now frozen at £325,000 until 2020/21, the value of the RNRB allowance will gradually increase over the next four years:
(After 2021, the maximum RNRB will increase in line with inflation.)
Sounds good so far.
The grey areas
The legislation sets out the requirements for a “qualifying residential interest,” and when this is “closely inherited” on somebody’s death the executors will be able claim the RNRB in addition to the NRB. There is also a ‘tapered threshold’ for properties valued above £2m, and the possibility to transfer the allowance.
But what does all this mean?
It is important to understand the definition of “closely inherited,” which would normally include spouses, civil partners, children and lineal descendants. But a gift of your home in certain trusts (such as discretionary trusts) may not necessarily qualify even if the beneficiaries are lineal decedents. This is where it gets complicated. You need to speak to a specialist solicitor or IHT specialist to get this right. Fortunately, this is our specialist area.
“Qualifying residential interest”
The qualifying residential interest is limited to one residential property. But, if there is more than one in the estate, you will be able to nominate which residential property should qualify. Furthermore, a property which was never a residence of the deceased, such as a buy-to-let property, will not qualify.
What about estates over £2m?
The new RNRB was designed to reduce tax bills for inheriting descendants, not to give the rich more tax breaks. So this new legislation comes with a catch: the RNRB will be reduced by £1 in every £2 that the estate is valued over £2m.
This tapered threshold could have an impact for farming families, and it’s important to understand this when it comes to tax planning. At first glance, the RNRB may appear to be a welcome IHT tax break. But it has to be looked at more closely because it could be whittled down, or it might not even apply.
First of all, it is the value of the overall estate (before reliefs) which is taken into consideration when looking at the £2m threshold for the RNRB. So, when a farmer dies the estate might be able to claim Agricultural Property Relief (APR) and Business Property Relief (BPR) to reduce the estate for tax purposes. However, that does not help in regard to the RNRB because it’s the value before the relief is deducted.
This Transferable Nil Rate Band (TRNB) has been around since 2007. Since then it has been possible to transfer any unused percentage of the inheritance tax nil-rate band (NRB) from a deceased spouse or civil partner to the surviving spouse or civil partner. The introduction of the new nil-rate band is yet more good news for couples. The RNRB can be transferred in the same way as the original NRB, if the second spouse or civil partner dies on or after today [April 6, 2017], and regardless of when the first of the couple died.
So a widower who lost his wife in 2012 can use both the NRB and the RNRB allowances.
But, with the arrival of a new piece of legislation, lots of work will be needed to discover how all these allowances fit together: how can the NRB, TNRB, the new RNRB, and, eventually the new transferable RNRB, be utilised and preserved?
Need more clarity?
The new legislation brings succession and tax planning back into sharp focus for rural families. But there are a few grey areas and every case will turn on the facts. If you are unclear about the rules contact our private client director, Deborah Adams, for a free consultation on 01566 772375 or firstname.lastname@example.org.
RNRB in action — how the new allowance applies to a farming estate worth more than £2m
Let us look at a basic example which focuses on the £2m threshold.
Denzil owns a farm in his sole name and dies in May 2017. His wife died a few years before and used up her NRB allowance. Denzil’s estate is made up as follows:
Farm cottage: £150,000
Farm land: £1,800,000
Cash & savings: £250,000
Denzil left his estate to his son who works off the farm. Denzil’s executors successfully claim 100% APR for the farm land. But the District Valuer and HMRC reduced his claim for 100% APR on the farmhouse and the farm cottage.
Denzil was semi-retired from farming and all of the land was let out, so HMRC argued successfully that there was non-agricultural value on the residence (and reduced it to 50%). The farm cottage was occupied by a non-agricultural worker under an assured short hold tenancy, so the District Valuer and the HMRC argued that the bungalow should not attract 100% APR.
As far as the IHT position was concerned Denzil has his NRB of £325,000. However, because his overall estate amounted to £2,550,000 the executors were not able to claim the RNRB when he died in 2017. Denzil’s estate had to pay IHT as follows:
Assets outside APR/BPR
Farmhouse value (50%): £175,000
Farm cottage: £150,000
Cash & Savings: £250,000
Taxable estate £250,000
IHT @ 40% £100,000
This leaves us pondering a few questions.
- Should Denzil have made a gift of the farmland before he died to bring the value of his estate under £2m?
- Should Denzil have made sure the cottage was occupied by a farm worker?
- Could Denzil have downsized?
- Should he have made sure his his son came back and actively farmed and lived in the farmhouse?
If this example makes you think about how your farm is structured and potentially how reliefs and tax allowances will impact upon your estate, it might be time to review your will, trusts, lifetime gifts. Deborah and her team are on hand to guide you through the new legislation on 01566 772375 or email@example.com.
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