Residential nil rate band: how to use the value of your home to save on inheritance tax

Everyone in the UK is entitled to a £325k tax-free allowance, which is applied to the estate upon your death; although this allowance reduces if you make certain gifts during your lifetime.

Additionally, married couples (or those in a civil partnership) who leave their estates to each other, are able to benefit from two nil rate bands, increasing the tax-free allowance total to £650k.

Estates with a value that falls within the respective allowances are exempt from paying tax; however, where the total value exceeds this amount, the excess sum will be taxed at 40%.

The residential nil rate band: an additional tax-free allowance for homes

In addition to the standard tax-free allowance, some people may also benefit from the residential nil rate band. This may be applicable if you pass your family home on to your children or grandchildren upon your death, providing a further tax-free allowance of £150k per person, increasing to £175k per person in April 2020.

Are you eligible for residential nil rate band?

The rules surrounding residential nil rate band are complicated and many estates fail to fulfil the certain criteria, which include:

• You must leave your residence to a ‘lineal descendant’: this includes children, grandchildren, stepchildren, adopted and foster children. A stepchild includes someone who was, at any time, your stepchild, meaning that you and your stepchild’s parent do not necessarily still need be married at the date of death. Children adopted by a third party are also included.
• You must have occupied the property at some point during your ownership: the property does not have to be your main residence, for example, your holiday home. Buy-to-lets that you have never lived in do not count.
• The allowance is limited to one property: upon death, your personal representatives will need to choose which home will benefit. If one property is worth more than another, it would usually make sense to apply the allowance to the more valuable one. Although, where there are two properties worth less than the residential nil rate band, some of the relief will unfortunately be wasted.

If you meet the conditions, less or even no tax is payable following your death, or that of a loved one. A married couple’s estate could potentially benefit from a £1m tax-free allowance before any inheritance tax is due, which is quite a considerable saving.

Large estates

In circumstances where your whole estate exceeds £2m, the tax-free allowance is tapered down by £1 for every £2 over this amount. Therefore, if its total value is in excess of £2.2m, it may be worth considering making gifts during your lifetime to reduce your estate’s value to below the £2m threshold.

While increased tax-free allowances are always welcome, the residential nil rate band is not an available option for everyone. For example, you will not be able to take full advantage of the scheme if you do not have qualifying ‘descendants’ or your property is of lower value.

It is, therefore, important to plan ahead and seek expert advice. As well as explaining the various other requirements that need to be met to claim the allowance, we can also help you get your affairs in order and review your will.