The new Inheritance Tax: "The Main Residence nil-rate band"

On or after April 6th 2017, the new Inheritance Tax rules will be of effect. The key point to consider is how this will affect your estate in terms of any Inheritance tax liability upon your death. Before we delve into this further, let’s start at the beginning…

Firstly, it is well acknowledged that we are living in a generation where more and more people own assets – be it investments, interests in a business, land, money and other property. However, the main asset in the vast majority of cases tends to be the family home. It has been indicated that the number of estates that will be subject to an inheritance tax liability is on the increase according to the Office for Budget Responsibility. This has been largely due to the surge in house prices year on year and the government’s stance in freezing the current nil-rate band of £325,000 since 2009 – that is the tax free allowance that an individual has before tax.

The government’s stance has simply not been in keeping with inflation and the rise in asset prices – in particular the family home. According to the Office for National Statistics “average house prices in the UK have increased by 7.2% in the year to December 2016 (up from 6.1% in the year to November 2016), continuing the strong growth seen since the end of 2013”.  This continued growth in the UK housing market has resulted in an average UK house price of £220,000 (December 2016). In the South West that figure is £243,000, and in some parts even higher. This means that more people are becoming asset rich because of the increase in value of their home and other assets. Thus, it is not uncommon for an average estate to exceed the current nil-rate band of £325,000 and so the 40 per cent tax due on any amount exceeding the nil-rate band is consuming families’ wealth.

How do the inheritance tax rules work?

Each individual in the UK is given a tax free allowance, known as the nil-rate band (“NRB”), before any tax is paid. Inheritance tax is paid on an estate that exceeds the current NRB of £325,000. Any amount that exceeds this will incur tax at 40 per cent (after taking into account the cumulative total of lifetime gifts made within 7 years of death or value of any chargeable lifetime transfers).

If you are married, or in a civil partnership then on the first death you can leave your estate to your spouse or civil partner free of inheritance tax. What is more, any unused NRB of your spouse or civil partner, on the first death, can be transferred on the second death so that the tax free allowance is effectively doubled to £650,000 (depending on the allowances available at the date of death of the respective spouses). Please note that the chargeable value is the value after deducting any liabilities, relief’s and exemptions that apply.

What will happen to the inheritance tax rules on April 6th 2017?

The forthcoming changes that will be operative on or after April 6th 2017 focus on the Main Residence nil-rate band” (“MRA”). The new rules provide some hope insofar that an additional £100,000, in 2017-2018, will be added to the current NRB. This will only apply to a “qualifying residential interest”, namely a residential property which had been the person’s residence at a time when a person’s estate included it, and is passed on death to direct descendants i.e. your child or children. The definition of a child includes step-children, foster children and children who have been adopted by a third party.

This means that on or after April 6th 2017 the current NRB for an individual leaving their main residence as part of their estate to their children will either have £425,000 allowance as an individual, or £850,000 for married or civil partners.  So the value of the MRA in 2017/2018 will be £100,000, but rising incrementally by £25,000 each tax year until it reaches £175,000 in 2020/2021, so that the tax free limit will be £500,000 per individual, or £1 million for married or civil partners.

The rules are complex and subject to various exceptions and even though there is no requirement that the property is the deceased’s main residence, it is necessary to show that it was a residence at some point. However, there are limitations including only one residential property that can be nominated if there is more than one in the estate. Buy to let or investment properties will not qualify if they were never used as a residence. Furthermore, the MRA will not apply in full to those with estates valued at more than £2 million but rather there will be a tapered withdrawal rate of £1 for every £2 over this threshold.

If an estate does not qualify for the MRA, then the existing nil-rate band will remain at £325,000, and this will be the case from 2018 to 2019 until the end of 2020 to 2021.

So even though there are complexities, various exceptions and limitations to the new rules, the MRA is at least a step in the right direction in reducing the number of families’ liable to pay inheritance tax.