So the chancellor made his Summer Budget speech on 8th July. Good News - Inheritance Tax allowances are increasing, Bad News – the new rules are by no means simple and are causing widespread confusion.
So what is the present situation?
Currently all individuals are entitled to pass on £325,000 of assets without any tax payable. Anything over this amount is taxed at a whacking 40% - therefore an estate of £400,000 would incur Inheritance Tax of £30,000 (£75,000*40%).
Married couples and civil partners are allowed to pass on their estate to each other and since October 2007 the surviving partner can now use both tax-free allowances, providing one has not been used on the first death. It should be noted that this does not happen automatically and must be claimed by the personal representatives of the second spouse / civil partner to die.
So what’s new?
The new proposed changes will bring in a new additional allowance for home owners known as the “Residence Nil Rate Band”. This additional amount of £175,000 per individual means that the first £500,000 of an estate is tax-free. As applies to the main Inheritance Tax threshold the personal representatives of a surviving partner can use both of the new allowances providing one has not been used on the first death. For married couples and civil partners this can mean that a combined estate of £1,000,000 can be left free of tax.
This all seems wonderful. However, as is so often with tax legislation, this is not effective immediately so you may want to delay taking your last breath for a few years yet. The new Residence Nil Rate Band won’t come in until April 2017 and even then it is being introduced on a gradual basis, as follows:-
April 2017/18 £100,000
April 2018/19 £125,000
April 2019/20 £150,000
April 2020/21 £175,000
For any individuals who die before the new Residence Nil Rate Band is introduced in 2017, it can be transferred to the surviving spouse, whose beneficiaries can then make use of both of the increased allowances. It should be also noted the new additional allowance is only available for individuals who own their own home and leave it to direct descendants, such as children, grandchildren and foster children. Adopted and Step-children are also included.
Larger estates worth more than £2 million will have the Residence Nil Rate Band reduced at a rate of £1 for every £2 above the £2 million threshold. The new allowance and the taper threshold will be increased in line with inflation (CPI) from 2021-22. The existing nil rate band of £325,000 will remain frozen until at least 2020-21.
Estates that do not have a home will not qualify for the new allowance. The exception to this is whereby a home is sold on or after 8 July 2015 and the equivalent value is passed to direct descendants. To qualify the house must have been the main home at some point. For estates with more than one house only one will qualify. The value of the house is also relevant if it is worth less than the Residence Nil Rate Band. For example assume an individual dies after April 2022 when the full allowance has been introduced and the estate is worth £500,000 but the home is worth just £100,000. In this situation the new Residence Nil Rate Band is reduced to £100,000, giving a total allowance of £425,000.
The ownership of the house is also an issue because in order to qualify the deceased must have had an interest in the property. So if a couple’s home is owned in the husband’s sole name and the wife dies, then the estate would not benefit from the increased allowance on the wife’s death. It would therefore be prudent to consider transferring a property from single to joint names to ensure both spouses qualify. It is important to note that where an individual dies before it is introduced in April 2017, the Residence Nil Rate Band is fully transferable to the spouse, regardless of whether the deceased spouse owned a share in the property.
So this is a most welcome boost for homeowners currently caught by the Inheritance Tax rules but care needs to be taken to ensure you qualify. As always taking appropriate advice and careful planning will pay dividends.