Understanding the family home inheritance tax allowance

In his summer Budget of 2015 the then Chancellor of the Exchequer George Osborne announced a measure that will allow many couples to bequeath up to £1 million to their heirs without their bequests being subject to Inheritance Tax (IHT). The mechanism by which this is being implemented is the family home allowance or, to give it its technical name, the main residence nil-rate band (RNRB), which is being phased in between 2017 and 2021.

The basics

Individuals’ estates each currently have a nil-rate band of £325,000, which means that they can pass assets on up to that value without IHT being applied. Assuming the first spouse bequeaths everything to his or her widow or widower then, upon the second death, their joint estate will not incur IHT on assets worth up to £650,000.

Any bequests above that level are usually subject to IHT, currently charged at 40 per cent.

The RNRB, which is being phased in gradually (see table below), will provide each individual’s estate with an additional nil-rate band of up to £175,000 or the value of the family home, whichever is the lower. The RNRB only applies where a main residence is bequeathed to direct descendants of the deceased (defined as children, stepchildren, adopted children or foster children, their lineal descendants and their spouses, civil partners, widows and widowers).

Like the standard nil-rate band, the RNRB can be inherited by a spouse/civil partner’s estate. This means that, from 6 April 2020, up to £350,000 can be added to the amount a couple can bequeath tax-free.

There are, however, a number of restrictions and the RNRB is “tapered away” for estates worth more than £2 million. Below we highlight some of the issues may need to be considered.

The good

  • The first spouse’s/civil partner’s RNRB can be added to the second at the full rate no matter how long ago they died.
  • The first spouse does not need to have owned/part-owned a home for the second spouse’s estate to inherit their RNRB.
  • If you downsize/have downsized to a cheaper property after July 2015 then the difference in value (at the time of its sale) between the more expensive and the cheaper property will be added back on to your RNRB.

The bad

  • The RNRB applies to just one residence and disproportionately benefits those with more expensive homes: from April 2020 it will be capped at the lower of £350,000 (for a couple’s estate) or the value of the family home. A couple’s estate with a home worth £500,000 and other assets worth £500,000 would benefit from the full RNRB but an estate with a family home worth £250,000 and other assets worth £750,000 would not, and – without further planning – would face an IHT bill of £40,000.
  • The “direct descendants” rule means that bequeathing the family home to your great-granddaughter’s husband will qualify for the RNRB but leaving it to your devoted niece who has nursed you for years won’t.
  • Estates have their RNRB reduced by £1 for every £2 of their total value above £2 million, so, once fully implemented, estates worth £2.7 million or more will not benefit at all (£2.5 million for the current tax year 2018/19).

The ugly

  • The RNRB can, like the standard nil-rate band, only be inherited between the estates of spouses or civil partners. Unmarried partners with direct descendants may, therefore, benefit from holding their homes as tenants in common (rather than the more usual joint tenants), with the first partner to die bequeathing their half of the house to their children or grandchildren – although the suitability of this course of action will very much depend on individual circumstances.
  • A future government may decide to abolish the RNRB so, as with so much of the tax system, it is impossible to plan with complete certainty.

Needless to say, the issues surrounding the RNRB, and IHT in general, are fiendishly complex and you should seek professional, expert advice before changing your will or carrying out any other form of estate or tax planning.

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