£1.0 Million Nil Rate Band – Is your home really protected from IHT?

01 November 2015

You could hear the cheers from those whose main asset is the family home in July 2015 when the Chancellor, George Osborne, announced that he would be introducing an additional nil rate inheritance tax (IHT) band applicable to an individual's main residence.

After the euphoria, the devil in the detail emerged revealing that some of the press coverage has been quite misleading, with some people thinking that they will have an allowance of £1 million each! Not true and many not realising that there are a series of important conditions that will need to be fulfilled before they can benefit from these planned changes.

Chapters Financial has detailed below how the new system is planned to work and what you might need to do to benefit fully from the increase in the inheritance allowance. Remember that this only starts in about 18 months' time at the start of the tax year 2017/2018.

IHT and the nil rate band

The existing nil rate band of £325,000 per person (or £650,000 for a married couple or a couple in a civil partnership) will remain the same – this proportion of your estate is sheltered from IHT, which is currently charged at 40% on the value of the estate above the level of the nil rate band.

From the tax year 2017/2018, an additional new main residence band of £100,000 per person will be introduced. This is planned to increase as follows:

Tax Year Additional main residence band

2018/2019 £125,000

2019/2020 £150,000

2020/2021 £175,000

After this, the main residence nil rate band will rise in line with the Consumer Prices Index (CPI) from the tax year 2021/2022 onwards.

In theory, this should mean that by the tax year 2020/2021, a house worth £1 million could be passed on with no liability to IHT. However, like so many things in life, it is not that simple. There are a range of rules you will need to follow to make sure that you are eligible to take advantage of the full £1 million allowance and we have detailed the key points below.

Are you married or in a civil partnership?

Under current IHT rules, only spouses or civil partners can inherit the other spouse/civil partner's share of an estate without using up any of the nil rate band. This means that the £325,000 nil rate band of a deceased spouse or civil partner can pass to the surviving individual, who will then have an IHT allowance of £650,000 on death.

When the new rules come in, the additional main residence band can also be passed on to a surviving spouse or civil partner, which means that in the tax year 2020/2021, a surviving spouse could have a maximum total IHT allowance of £1 million (two nil rate bands of £325,000 plus two additional main residence bands of £175,000).

However, if you are living with a partner but not married or in a civil partnership, you cannot pass on your nil rate band to the surviving partner. This means that the maximum total allowance for an unmarried couple will be limited to that of an individual at £500,000 (one nil rate band of £325,000 plus one additional main residence band of £175,000).

Will you be using your nil rate band elsewhere?

As noted above, it is only spouses and civil partners who can inherit the other person's share of an estate without any liability to IHT. If bequests are made in your Will to individuals other than your spouse or civil partner, these will use up a proportion of your nil rate band and therefore your spouse will not be entitled to the full £1 million allowance.

You will also need to bear in mind any financial gifts you may have made to friends and family over recent years. Monetary gifts to anyone other than a spouse or civil partner, and over the annual exempt gift allowance of £3,000 total, are classified as 'potentially exempt transfers' (PETs) and you need to survive for seven years before the gift falls entirely outside your estate for IHT purposes. If you die before the seven years is up, the gift may be liable to IHT and could therefore erode the IHT allowance that passes to your spouse.

Who do you plan to leave your house to?

If it's anyone apart from your children or grandchildren, then you might want to consider this point. The aim of these IHT reforms is to allow the family home to remain within the family. So, in order to qualify for the new additional main residence IHT bands, the main residence has to be left to direct lineal descendants of the deceased – in other words, children (including step, adopted or foster children) and their lineal descendants. Nephews and nieces of the deceased do not qualify.

Don't be too hasty…

The full £1.0 million allowance is being phased in over the next five years – it's not available at the moment, despite what the press headlines in July might have indicated. The measure will only take effect for relevant transfers on death on or after 06 April 2017. As an example, if a married person dies in the 2017/2018 tax year and passes on their full nil rate band to their surviving partner, a main residence to the value of £850,000 can pass free of IHT to children or grandchildren (2 x £325,000 plus 2 x £100,000).

…and what if I sell my main residence?

It was announced in the Summer Budget of July 2015 that anyone who downsizes or ceases to own a home on or after 08 July 2015 will still be able to use the main residence nil rate band when assets of an equivalent value are passed on death to direct descendants. Legislation to this effect is intended to be included in the Finance Bill 2016, to ensure that those who want to downsize or cease to own property are not discouraged from doing so. It is important to bear in mind that these proposals may be altered before becoming legislation.

Which properties will qualify for the main residence nil rate band?

The Government has stated that the main residence nil rate band allowance will be limited to one residential property, although personal representatives of the deceased will be able to nominate which residential property should qualify, if there is more than one included in the estate. A property which was never a residence of the deceased (e.g. a buy to let property) will not qualify.

Estates worth over £2.0 million

There will be a tapered withdrawal of the additional main residence nil rate band for estates with a net value of over £2 million. The additional nil rate band will be tapered away by £1 for every £2 that the net value of the estate exceeds this amount. The taper threshold at which the additional nil rate band is withdrawn will rise in line with CPI from the 2021/2022 tax year onwards.

As with all the Chapters Financial blogs, no individual advice is provided in the above text. If you would like to discuss your inheritance tax and estate planning then please contact the team in either Guildford or Woking.

We also produce a printed newsletter on a regular basis and if you would like a copy of this then please email the office at Guildford or Woking directly.

Vicky Fulcher Dip PFS
Financial Planner

Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.

Not all aspects of Inheritance Tax and estate planning are regulated by the Financial Conduct Authority.