Changes to the Inheritance Tax system could have far-reaching implications for homeowners
Recent post-Budget analysis may have concentrated on the U-turn over National Insurance for the self-employed, but another tax change introduced on 6 April 2017 could have far-reaching implications for homeowners.
This tax change means parents and grandparents are able to leave homes worth up to £850,000 to their children and grandchildren without them paying inheritance tax. This tax-free allowance is set to rise to £1 million by 2020. This was originally announced by George Osborne, not Philip Hammond, as part of his long-term plan to reduce the impact of Inheritance Tax (IHT) on ordinary families. But what are the thresholds, rates and allowances? Here is our guide to Inheritance Tax.
How does Inheritance Tax work?
Under the old system, inheritance tax is charged at 40 per cent on the portion of the deceased’s estate worth £325,000 or more. This means no inheritance tax is charged on the first £325,000 (per person) of someone’s estate. This is called the nil-rate band.
Spouses and civil partners could pass all their wealth to each other without tax. However, tax may be payable when wealth is transferred down generations. Nil-rate bands can also be passed between spouses. In other words, the surviving spouse can inherit the entire estate without having to pay Inheritance Tax. Couples could leave a home worth £650,000 without it attracting inheritance tax (singles £325,000). This remains unchanged. Above the threshold, the charge is 40% of the value of the property.
What has changed?
A new IHT Residence Nil Rate Band (RNRB) was introduced on 6 April 2017. This is better known as the ‘family home allowance’. It is a new allowance of an extra £100,000 per person to use against the value of their home and a further £25,000 will be phased in every year over four years, rising to £175,000 by 2020. This will be added to the existing £325,000 nil-rate tax band. In other words from April 2017, an individual will be able to pass on £425,000 without paying Inheritance Tax as long as it includes the family home and passes directly to children or grandchildren and not via a discretionary trust. And by April 2020, this sum will rise to £500,000.
The changes mean the maximum that can be passed on tax-free is £850,000 for married couples or those in a civil partnership, £425,000 for others.
For singles, this is made up of the existing £325,000, plus the extra £100,000. For couples, when the first one dies their allowance is passed to the survivor, so that £425,000 is doubled to £850,000.
The new RNRB only applies if an individual dies on or after 6 April 2017, if their estate includes a property that they own or part own, and if their direct descendants such as children or grandchildren inherit the property or part of it.
Who will benefit?
– Those who are passing the family home to children, grandchildren or surviving spouses.
– Those who have an estate below £2million.
– The RNRB could still be reclaimable in situations where a property has been sold, perhaps because the owner has downsized or moved to a residential care home – provided it was sold after July 2015. This is another area where it is important for homeowners to clarify their situation. The government’s website also includes information on this area: www.gov.uk/topic/personal-tax/inheritance-tax
The RNRB will be transferable between spouses and civil partners on death, just like the existing nil-rate ban. Thus the unused RNRB from the estate of the first to die can be claimed on the second death, raising the total RNRB to £1million. For a couple, this means a £1million family home can be left tax free to their children.
One likely consequence of the change may be to encourage retired homeowners to hold on to large properties rather than sell up and rent. “They will know that, by 2020, with proper planning, their children will be able to inherit £1million of their wealth free of tax,” says Ralph Crathorne, Partner in Land Management at Strutt & Parker. “That can only be good for the property market.”
Who might miss out?
– Those with estates worth in excess of £2million will see little or no benefit from the new RNRB, which will be reduced by £1 for every £2 that the deceased’s net estate exceeds £2 million.
– The RNRB could potentially be lost if a property has been placed in a discretionary trust for children or grandchildren. But not all trusts fall foul of the new rules, so it is important to seek legal advice on this point.
– Only one residential property can qualify for the purposes of the new RNRB. Properties which were never residences, such as buy-to-lets, will not qualify.
– The new rules may make it harder for homeowners not domiciled in the UK to avoid paying IHT on UK residential property. “In the past,’ explains James Jones of Knight Frank Finance, “a non-domiciled individual would typically hold the property via a non-resident company held by a trust. But now the shares in such companies will be liable to UK IHT.”
The changes in IHT are so complex and far-reaching that those in any doubt about their position should review their wills as a matter of priority and consider taking appropriate advice, to ensure that they maximise the benefits to their estate.