Inheritance tax isn’t just for the very wealthy, and many families could be liable for inheritance tax without realising it. Our Wills, Trusts, Tax and Probate experts explain the rules about inheritance tax.
When you die, everything you owned at the time of your death is included as part of your estate. If you own your own home, you can leave it to your spouse or civil partner free of inheritance tax. If you leave your house to someone else (for example, a friend or relative) it will count towards the value of your estate. Homeowners need to be aware of this, and plan accordingly. Inheritance tax is payable on your estate – which is formed from the assets you owned at the date of your death. Your assets can include things like property, savings, investments and personal belongings.
Has the value of your home increased? If it has, you may be liable for inheritance tax without realising it because your house is worth more than it was when you purchased it. Think about your inheritance tax liability well in advance, and take proactive steps to protect yourself. Otherwise, you could end up paying more inheritance tax than you need to.
How does inheritance tax work?
Inheritance tax is usually a one-off tax payment, due from your estate after your death. Inheritance tax is potentially payable on all assets within your estate, unless your assets have the benefit of any relief such as business property or agricultural relief. Inheritance tax can also be due on gifts made during your lifetime.
The current basic inheritance tax threshold is £325,000 for an individual. If the value of your estate exceeds this amount, and does not have the benefit of any tax reliefs, inheritance tax will be payable at 40% on the amount that exceeds the £325,000 threshold. The threshold can be transferred to the estate of a surviving spouse; so a married couple or civil partners can benefit from a combined basic inheritance tax threshold of £650,000.
Inheritance tax update: the new residence nil rate band allowance
The residence nil rate band (RNRB), sometimes referred to as the ‘family home allowance’, was introduced in April 2017. Under certain conditions, the RNRB can provide relief from inheritance tax. So, it can help to reduce your inheritance tax bill.
For the 2017-2018 tax year, the RNRB is an additional threshold of £100,000 which may be added to the basic inheritance tax threshold if certain conditions are met.
The allowance will be phased in gradually between now and 2020 (when the maximum RNRB available to an individual will have increased to £175,000). By 2020 a married couple or civil partners could be able to leave combined assets worth up to £1million on their death free from inheritance tax. However, the RNRB allowance does not apply to everyone and many estates will still be liable for inheritance tax, regardless of the changes.
How does the residence nil rate band work?
The RNRB allowance is only available when the family home (or a share of it) passes on to a direct descendant following death. Direct descendants include children and grandchildren (including step children, fostered and adopted children).
Only direct descendants can benefit from the RNRB. Therefore, if you leave your home to a sibling, niece, nephew or cousin, for example, the allowance will not be available.
The allowance can only be applied against one residential property per person. If there is no property within your estate then the allowance will not be available. There are some exceptions to this rule. For example, if you sold your property (on or after 8 July 2015) to fund care home fees or to downsize, your estate should still be able to benefit from the RNRB (again subject to certain conditions).
How the residence nil rate band could affect you
If your estate is worth over £2m, the RNRB will be reduced by £1 for every £2 of value over £2m. This means that in this tax year (2017-2018) estates that are worth in excess of £2,200,000 will not benefit from the RNRB.
The potential availability of the RNRB will have some very positive tax consequences for many families. However, the operation of the RNRB rules can be complex and expert advice is essential to ensure that your estate enjoys full benefit of the new allowance.
Although a married couple could have a combined family home allowance of £350,000 by 2020, with the average residential property in the UK now worth around £220,000, many family homes are likely to exceed the threshold. For those living in London and the South East, the new allowance could ease, but not eliminate, their potential inheritance tax burden.
How to minimise your inheritance tax bill
To minimise your liability for inheritance tax, make sure your will is up to date and tax efficient. In turn, this will help to maximise the amount that you are able to pass on to your loved ones on your death.
Every individual’s circumstances differ and therefore seeking professional guidance on inheritance tax matters is essential.
Call our specialist Wills, Trusts, Tax and Probate team on 0800 0131165 for clear, practical advice on any issue relating to inheritance tax.
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Chat to the Author, Letty Glaister
Partner - Wills, trusts, tax & probate, Royston officeMeet Letty