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Beware of IHT anomaly on residence nil-rate band

Despite Philip Hammond’s attempt to create a smoother process, the theoretical £1 million IHT-free threshold is a potential misnomer for those inheriting property

Beware of IHT anomaly on residence nil-rate band

Much has been written on the residence nil-rate band (RNRB). But you could still be forgiven for thinking the legislative changes in April 2017 gave your estate a £1 million inheritance tax (IHT)-free threshold.

Despite the introduction of the RNRB by the chancellor being part of his efforts to make the IHT process ‘as smooth as possible’, scratching the surface reveals there is more to think about.

The current RNRB is £125,000, rising by £25,000 each year until it reaches £175,000 in 2020, which – when added to the £325,000 provided by the nil-rate band (NRB) – equates to the £1 million figure trumpeted on its announcement.

Therefore, estates of individuals dying in this tax year could currently have a tax-free inheritance threshold of £450,000, rising to £475,000 on 6 April 2019. The intention is the RNRB will be protected against inflation, increasing annually in line with the consumer prices index (CPI) beyond the 2020/21 tax year.

The RNRB is only available when a qualifying residential interest, which is a property the deceased has lived in at some point, is being passed to a direct descendent. Simple, right?

Not quite. HM Revenue and Customs qualifies ‘direct descendants’ as:

  • a child, grandchild or other lineal descendant;
  • a husband, wife or civil partner of a lineal descendant (including their widow, widower or surviving civil partner).
  • However, for parents passing down wealth on their death, this also extends to:
  • a child who is, or was at any time, their step child;
  • adopted children;
  • a child who was fostered at any time by them;
  • a child where they are appointed as a guardian or special guardian when the child is under 18.

When the property in question is inherited by direct descendants in part only, the proportion of the property inherited will be reflected in the application of the RNRB. In other words, the RNRB will be restricted to the value of the proportion inherited, not the total value of the house.

Bitter implications

The Royal Institution of Chartered Surveyors’ (RICS) 2019 housing forecast suggests prices will ‘neither grow nor fall in the near future’. But Simon Rubinsohn, chief economist at the RICS said: ‘Looking a little further out, there is some comfort provided by the suggestion transactions nationally should stabilise as some of the fog lifts.’

Just in time for the application of the CPI-linked increase to the RNRB – which, if the price rises outstrip the rate of CPI increase – there will be increased liabilities for those on or above the nil-rate threshold. This will only be enhanced for those with large property portfolios and compounded if you are on or above the £2 million threshold, where tapering of the RNRB applies.

Whereas the recent stagnation of the housing market and the prescribed increases in the RNRB up to 2020/21 provide some solace, increases to house prices have outstripped the CPI. As main residences often represent large proportions of estates, the pending implications deserve more attention.

It is a common misconception that some elements that are zero-rated for IHT purposes sit outside the estate for the £2 million threshold for tapering. This is a consideration for those expecting considerable breaks due to business relief, which is often used in certain IHT-efficient investment schemes and as a key tax break for business owners. The value of such assets would be included in the valuation of the estate on death, which could have significant consequences on the RNRB.

The implications of the legislation are far-reaching and more complex than the chancellor’s ‘smooth’ intentions, which is one reason they are still widely misunderstood. Many commentators have suggested modifications may be made as a result of the current wider review of IHT.

Glen Marshall is a wealth management consultant at Mattioli Woods

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