A first look at the new Inheritance Tax Main Residence nil rate band

Author: Helena Luckhurst

In his Summer 2015 Budget, the Chancellor has extended the scope of Inheritance Tax (IHT) so that more ‘non-doms’ will have to pay IHT on their UK residential property. However, what the Chancellor takes away with one hand, he gives with another! And so, individuals who personally own a UK residence, whether UK domiciled or not, are getting an IHT tax break.

For deaths occurring on or after 6 April 2017, the Government proposes that an additional IHT nil rate band, the Main Residence nil rate band, will be available, as long as the residence passes to a direct descendant. For married couples and civil partners, this means that assets of up to £1 million can pass free of IHT but, as always, there are conditions to be fulfilled.

The Main Residence nil rate band will be phased in incrementally. The Main Residence nil rate band will be £100,000 in tax year 2017/2018, £125,000 and £150,000 respectively in the following two tax years, reaching £175,000 in 2020/2021 and increasing in line with the Consumer Prices Index (CPI) thereafter.

The existing IHT nil rate band will now remain at £325,000 until tax year 2021/2022 (prior to the Summer Budget, the IHT nil rate band was due to rise in line with the CPI from 2018/2019).

Married couples and civil partners will enjoy two Main Residence nil rate bands, even if all assets are left to the survivor after the first death. In other words, it will not be necessary for a husband to leave his half share of the main residence to his children, rather than to his surviving wife, in order to secure the Main Residence nil rate band. The surviving wife’s executors will be able to claim the husband’s Main Residence nil rate band, as well as the wife’s, after the wife’s death. This will be the case as long as the second spouse dies on or after 6 April 2017. It does not matter when the death of the first spouse occurred.

I had feared that this would result in ‘land banking’, as children of elderly parents were forced to keep hold of their parents’ home, even if their parents’ welfare and healthcare needs would be better met if they moved out to be cared for in a residential or nursing home. However, the Government appears to have foreseen this issue by stating that it intends the Main Residence nil rate band to be available still, even if a person downsizes to a less valuable residence or ceases to own a home on or after 8 July 2015 (although the death must occur (or if a married couple, the second spouse’s death must occur) on or after 6 April 2017). The condition attached to this is that the smaller residence, or assets equivalent in value to the sold residence, must pass to the direct descendants. How this will work if there are insufficient assets available remains to be seen.

Buy-to-let properties will not qualify unless they have been a residence at some point during the period of ownership.

The sting in the tail is that if an individual dies with an estate with a net value of more than £2 million, the additional nil rate band suffers a tapered withdrawal, at a rate of £1 for every £2 of net estate over the £2 million threshold. This threshold will also rise in line with the CPI after 2021/2022.

The imposition of a threshold might encourage lifetime giving of assets other than the home, if by doing so it is feasible to depress the estate below £2 million. However, these changes will also be a further disincentive to make lifetime gifts of the main residence for those individuals where using the additional nil rate band will make a material difference to their IHT exposure, as the additional nil rate band will not be available to relieve the IHT burden on a lifetime gift of the main residence which the giver fails to survive by seven years.

It will be interesting to see if an outright distribution to a child is a precondition or whether passing the residence into a trust for the child, if the child is too young to inherit, will still allow the additional nil rate band to be claimed.

Direct descendants includes step-, adopted and foster children. But will these new measures introduce a bar to testamentary freedom, for parents wanting to minimise the IHT payable on their estates? They may be forced to leave their home to their children, even if they would prefer it to go elsewhere. English will makers are not used to being told whom to leave their assets to!

The draft legislation to implement this change will be included in the Summer Finance Bill 2015, due to be published on 15 July 2015. This is one to watch for the moment but, unlike some of the other measures introduced by the Chancellor in his latest Budget, we should not have to wait too long before we know how this latest twist in the tale of IHT planning with the main residence will pan out.

Helena Luckhurst, Partner, Fladgate LLP (hluckhurst@fladgate.com)

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