Dead simple

Technical Connection’s Niki Patel provides a reminder of the fundamentals and planning options around the Residence Nil Rate Band

The Residence Nil Rate Band (RNRB) came into effect for deaths on or after 6 April 2017 and is applied before the standard nil rate band (NRB). For married couples and civil partners, like the standard NRB, any unused percentage of the RNRB can be transferred if the surviving spouse or civil partner dies after 5 April 2017, irrespective of when the first of the couple died. For the 2021/2022 tax year, the RNRB is set at £175,000 – and it is expected to remain at this level until 2025/2026.

The standard NRB has remained at £325,000 since 2009/2010 and is also expected to remain at this level until 2025/2026. With these bands being ‘frozen’, more and more clients are likely to wish to plan in this area. Our technical refresher provides a reminder of the inheritance tax (IHT) exemptions, whereas here I focus on the fundamentals of the RNRB and possible planning options that could be considered.

Unlike the standard NRB, the RNRB will only be available provided that a ‘qualifying residential interest’ is ‘closely inherited’ by a direct descendant – although there is an exception where the downsizing provisions apply, in which case other assets in the estate must be closely inherited.

The ‘value’ of the RNRB for an estate will be the lower of the net value of the interest in the home (after deducting any liabilities such as a mortgage) or the maximum amount of the band.

Further, the amount of RNRB is reduced (tapered) by £1 for every £2 where the value of the total estate is in excess of £2m.

Qualifying residential interest

A qualifying residential interest (QRI) is basically an interest in a residential property that has been occupied by the deceased as a residence, at a time when the property was included in the deceased’s estate.

A QRI does not therefore include any investment (buy-to-let) properties that the deceased may have owned, unless of course that property had been occupied by the deceased as a residence at some time.

For these purposes, it is also possible for houseboats and caravans to be treated as a dwelling for the purposes of the RNRB, provided that it can be proven that the deceased lived there.

Where the deceased owns more than one property it will be up to the deceased’s executors to nominate which property should be treated as a QRI and ensure that the property they nominate has been closely inherited.

Closely inherited

A QRI will be closely inherited provided that it passes to a direct descendant. A direct descendant is any one or more of:

• The deceased’s children, grandchildren or other lineal descendant.

• A husband, wife or civil partner of a lineal descendant – including their widow, widower or surviving civil partner (provided that they have not remarried/formed another civil partnership as at the date of death of the property owner).

Note, for these purposes, ‘children’ includes adopted, fostered, step-children and any children for whom the deceased acted as guardian while they were under 18; and the children/grandchildren of all such children.

In some cases, property settled in trust on death for those falling within one of the above categories will also be treated as closely inherited – please see the section below, entitled ‘Will trusts and the RNRB’.

Value of the RNRB

As mentioned above, the value of the RNRB will be the lower of the net value of the interest in the home (after deducting any liabilities such as a mortgage) or the maximum amount of the band.

Example:

Stan’s wife Charlotte died three years ago, leaving her entire estate to him. At the time of her death, her total estate was worth well below £2m and she had not made any lifetime gifts. This would mean that the unused percentage of Charlotte’s NRB and RNRB would be 100%.

At the time of Stan’s death in 2022, his residential property is worth £475,000, however, there is an outstanding mortgage of £200,000 secured against it. Under the terms of his will, he leaves all of his estate to his son and daughter in equal shares absolutely. In this case, while the RNRB should ordinarily be £350,000 (i.e. £175,000 x 2), it would actually be restricted to £275,000 (i.e. £475,000 minus £200,000).

Estates in excess of £2m

Where the total value of the estate is in excess of £2m, the RNRB is reduced by £1 for every £2 of that excess. This means that the tapering rules can reduce the RNRB to nil. For the purposes of these rules, you have to consider the position on each respective death. Based on an RNRB figure of £175,000, there will be no RNRB if the estate exceeds £2.35m, or £2.7m including 100% of any unused allowance if available.

The value of the estate for taper purposes is the total value of all the assets in the deceased’s estate, less any debts or liabilities. In working out the value of the estate, you do not deduct any:

• Exemptions such as the spouse/civil partner exemption.

• Reliefs such as agricultural or business relief.

Example:

Dilan has never been married before but does have a daughter from a previous relationship. On his death in 2021, he owns a property worth £650,000. He also owns shares of £230,000 that qualify for business relief and other assets worth £1.3m. There is an outstanding mortgage of £50,000 secured against the property. Under the terms of his will, all of his assets pass to his son absolutely.

His estate for the purposes of the RNRB would therefore be:

Property          £600,000

Shares             £230,000

Other assets    £1.3m

Total                 £2.13m

Given that Dilan’s estate is worth more than £2m, the tapering rules would apply:

£2.13m minus £2m = £130,000/2 = £65,000

 The RNRB available would therefore be £110,000

(i.e. £175,000 minus £65,000).

The downsizing provisions

To benefit from the RNRB, an individual doesn’t have to own a property at the time of their death. This is because the rules take into account that individuals who downsize to a smaller and less valuable property or dispose of their property and move into rented or residential care, will, if certain conditions are met, be compensated for any lost RNRB with a ‘downsizing addition’.

The following points must apply:

• The property must have been owned by the person and it would have qualified for the RNRB had they retained it.

• The person must have sold, given away or downsized to a less valuable home, on or after 8 July 2015, and lost out on all or part of the RNRB as a result.

• Their direct descendants inherit some of their assets on death.

The downsizing provisions are complicated. In accordance with HMRC’s guidance, it is necessary to carry out a five-step calculation to work out how much RNRB has been lost:

1. Work out the RNRB that would have been available when the former home was sold or given away or when the move happened. This figure is made up of the maximum RNRB due at that date (or £100,000 if it was before 6 April 2017) and any transferred RNRB available when the person dies.

2. Divide the value of the former home at the date it was disposed of by the figure in step one and multiply the result by 100 to get a percentage. If the value of the former home is greater than the figure in step one, the percentage will be limited to 100%. If the value of the home sold is less than the figure in step one, the percentage will be between 0% and 100%.

3. If there’s a home in the estate, divide the value of the home by the RNRB that would be available at the date the person dies (including any transferred RNRB). Multiply the result by 100 to get a percentage (again this percentage cannot be more than 100%). If there’s no home in the estate at the time the person dies, this percentage will be 0%.

4. Deduct the percentage in step three from the percentage in step two.

5. Multiply the RNRB that would be available at the time the person died by the figure from step four. This gives the amount of the lost RNRB.

Note it is only possible to take one move, sale or other disposal of a former home into account for the downsizing addition.

Example

Betty’s husband died a year ago, not having used his RNRB. Betty moves into residential care and sells the property, which is worth £210,000 in August 2018. The maximum RNRB when she sold the home is £125,000 (2018/2019 tax year).

Betty died in August 2020 with no home in her estate. The maximum RNRB in 2020/2021 is £175,000.

To calculate the lost RNRB:

1. The maximum RNRB when the home was sold was £125,000. Betty’s estate is also entitled to the transferred RNRB of £175,000. So, the total RNRB that could have been available when the home was sold is £300,000 (£125,000 plus £175,000).

2. When sold, the home was worth £210,000. Divide this by the value at step one (£300,000) to give a percentage of 70%.

3. There’s no home in the estate when Betty dies, so the percentage is 0%.

4. Taking 0% from 70% gives a percentage of 70%.

5. When Betty dies, the maximum RNRB is £175,000. Her estate is also entitled to the transferred RNRB of £175,000, so the maximum RNRB for her estate is £350,000. The ‘lost’ RNRB is £245,000 (70% of £350,000).

Although the lost RNRB is £245,000, the amount of the downsizing addition available to her estate depends on the value of any other assets she leaves to her direct descendants.

Planning options

Having covered some of the fundamentals, I will now go on to look at some possible planning options that could be considered to benefit from the RNRB in cases where it may be otherwise lost.

Gifting to reduce the estate to less than £2m

As mentioned above, the amount of the RNRB is tapered by £1 for every £2 where the value of the estate is in excess of £2m. The position needs to be considered on each person’s death.

Example:

Mary has one child, Jacob, who will benefit from her entire estate on her death. Mary has never been married. Mary’s estate included a property valued at £500,000 and other assets of £2m. There is an outstanding mortgage of £100,000 secured against the property.

The value of Mary’s estate is therefore:

£500,000 minus £100,000 = £400,000; plus £2m = £2.4m

If she were to die in 2021, the RNRB would ordinarily be £175,000. However, as the value of her estate exceeds the RNRB taper threshold by £400,000, her estate will not benefit from an RNRB.

The IHT payable would therefore be £2.4m minus £325,000 = £2.075m; x 40% = £830,000

Had Mary made a gift of £400,000 to Jacob in her lifetime, the value of her estate would reduce to £2m and the estate would then benefit from an RNRB of £175,000.

If Mary does not survive seven years, the IHT position on her estate would be as follows:

£2m minus £175,000 = £1.825m; x 40% = £730,000

Note this tax is in addition to the IHT payable on the failed gift (potentially exempt transfer).

If, however, Mary does survive seven years, the position would be as follows:

 £2m minus £175,000 minus £325,000 = £1.5m;x 40% = £600,000

The rules regarding the RNRB can be complex, however, a general understanding will be vital to those giving advice in this area

Using the NRB rate band on first death

Another option which could be explored in light of both the taper threshold and the fact that the NRB has remained at £325,000 since 2009/2010 and is expected to remain at this level until 2025/2026, is whether married couples/civil partners wish to consider using their NRB on first death to reduce the value of the survivor’s estate on second death. Further, any growth would also be outside of the estate on second death, thereby enhancing IHT savings further.

Example:

Eric and Claire are married and have three children. Their family home is worth £750,000. Their combined estate is worth £2.3m and their wills leave everything to each other.

Let’s say Eric dies first. On his death, there will be no IHT to pay because the spouse exemption will apply. His share of their estate was worth below

£2m, therefore Eric’s unused RNRB is available for transfer to Claire.

On Claire’s death, on the basis that the total estate is £2.3m, her estate would benefit from the NRB of £325,000 and a transferable NRB of £325,000 from Eric. Ordinarily, there would also be two RNRBs of £175,000 each available – so £350,000 in total. However, as the estate exceeds the taper threshold by £300,000, the RNRB available to her estate is reduced by £150,000 to £25,000. The unused RNRB on Eric’s death would still be available for transfer, so £200,000 in total.

IHT would therefore be based on £2.3m minus £650,000 minus £200,000 = £1.45m

Tax to pay = £580,000

If Eric’s will had been drafted to include a NRB discretionary trust that received £325,000, Claire’s estate would then have been worth £1.975m. This would mean that her estate would not then have exceeded the taper threshold and would benefit from two RNRBs, totalling £350,000. She would only benefit from her own NRB, as Eric would have used his NRB under the terms of his will.

IHT would therefore be based on £1.975m minus £325,000 minus £350,000 = £1.3m

Tax to pay = £520,000

The tax saving is therefore based on the otherwise ‘lost’ RNRB as a result of the tapering rules.

Debt secured against the property

As mentioned above, the value of the RNRB for an estate will be the lower of the net value of the interest in the home (after deducting any liabilities such as a mortgage) or the maximum amount of the band.

Example:

Brian’s wife died six years ago, leaving her entire estate to him. At the time of his death in 2021, his residential property is worth £460,000 and his other assets are worth £700,000. There is an outstanding mortgage of £180,000 secured against the property.

Under the terms of his will, all of the assets in his estate pass to his daughter absolutely.

While the RNRB would ordinarily be £350,000 (i.e. £175,000 x 2) after taking account of the transferable RNRB, in this case however, it would be restricted to £280,000 (i.e. £460,000 minus £180,000).

If Brian had reduced his mortgage by £70,000, the RNRB available would be £350,000, which would give rise to an IHT saving of £28,000.

It is also important to point out the if the debt had been secured against another asset in the estate, the full £350,000 RNRB would have been available – it is only a loan secured on the house that reduces the amount of RNRB potentially available.

Will trusts and the RNRB

In certain circumstances, property settled in trust on death will also be deemed to have been closely inherited. Basically, this will be where the property is to be held either absolutely for the benefit of someone falling within the extended definition of a direct descendant; or on qualifying interest in possession trusts for such a person (in other words a trust where the direct descendant has either an immediate post-death interest (IPDI) or a disabled person’s interest). Property will also be deemed to be closely inherited where it is left to a bereaved minor’s trust or an 18-25 trust, where the beneficiaries will, by definition, be the children of the deceased.

In cases where the deceased wishes to provide trustees with maximum flexibility in the way in which the estate, or part of it, is distributed, they could decide to create a discretionary trust in their will. In cases where the property or a share of it is left to a discretionary will trust, the RNRB will not be available because the share of the property is not being closely inherited – even if the beneficiaries only include the deceased’s children and/or grandchildren.

If, however, within two years of death, there is an appointment of the trust assets by the trustees to a direct descendant, then it would be treated for IHT purposes as if the assets had been left to the direct descendant outright (S144 IHTA 1984). In that event, the RNRB would be available, as the direct descendant is treated as if they had inherited the property on death.

Making use of three or four RNRBs

In some cases, there may be the opportunity to use more than one RNRB where, for example, one or both parties have been previously widowed.

Example:

Gerry and Nicola were married. Gerry died in 2017, leaving his entire estate to Nicola absolutely. On Gerry’s death, his estate was worth less than £2m, therefore Gerry’s unused RNRB is available for transfer to Nicola.

Nicola subsequently marries Henry in 2020. If Nicola dies first and leaves her entire estate, also worth less than £2m, to Henry absolutely, on his death his estate will make use of his RNRB and Nicola’s unused RNRB. Gerry’s unused RNRB will therefore be wasted.

If Henry were to die first, again leaving his estate to Nicola absolutely, on her death her estate will make use of her RNRB and Henry’s unused RNRB. Gerry’s unused RNRB will therefore again be wasted. Remember that even though Nicola could have potentially benefited from Gerry’s unused RNRB, the maximum amount available for transfer is 100% of any unused RNRB.

It would therefore be advisable for Nicola to ensure that her will is drafted to at least use one of the RNRBs available to her should she die before Henry. This would ensure that Gerry’s unused RNRB is at the very least used on Nicola’s death. Then, on Henry’s subsequent death, his estate could use his RNRB and Nicola’s unused RNRB – thereby making use of three RNRBs in total.

In addition, Henry may also wish to consider using his own RNRB should he die before Nicola, because then his estate can take advantage of his RNRB; and on Nicola’s subsequent death, her estate can use her RNRB as well as Gerry’s unused RNRB.

Further, had Henry been previously widowed, then again careful drafting of each of Henry and Nicola’s respective wills could mean that a total of four RNRBs could be used – of course, in each case it is essential to ensure that the estate on each respective death was worth less than £2m, so not subject to the tapering rules, and that the residential interest is left to a direct descendant.

It may also be advisable to ensure the RNRB is used on first death of unmarried partners who may have children/grandchildren that they wish to leave a QRI to.

Deeds of variation

It is possible for a beneficiary to execute a deed of variation. For IHT purposes, it is vital that the necessary conditions are satisfied for the variation to be treated as having been made by the deceased. Broadly, the variation must be made within two years of death, it must be in writing, it must contain a statement that section 142 of the Inheritance

Tax Act (s142) 1984 applies, and it must not be for consideration.

Example:

Clive and Hayley have been living together for five years but are not married. Both have been married before and Clive has a daughter who currently lives with them.

On Clive’s death, he leaves his tenant-in-common share of the property, which is valued at £200,000, to Hayley. Because they are not married, this transfer would not be exempt and there would be no RNRB available as Hayley is not a direct descendant.

If Hayley enters into a deed of variation and passes Clive’s share of the property to his daughter, it wouldbe possible to benefit from the RNRB because she is a direct descendant.

Conclusion

The rules regarding the RNRB can be complex, however, a general understanding will be vital to those giving advice in this area. Clients need to be made aware of these rules and consider their own personal circumstances to ensure the estate can benefit from the RNRB or carry out any planning in order to do so. Clients should also consider reviewing existing wills written prior to the introduction of the RNRB,to see if any changes need to be made to maximise IHT savings.

Niki Patel is a tax and trust specialist at Technical Connection

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