We are a husband and wife in our 80s, and own our home as tenants in common. We have a daughter who has always lived with us, and she and our two other children will be the beneficiaries and executors of our estates.
We each intend to leave our entire estate equally to the three children, including our 50 per cent share of the home, and pay whatever inheritance tax (IHT) is due.
After the death of the first spouse, the surviving spouse and daughter will remain in the home and not make rental payments to the beneficiaries. Two beneficiaries who own two-thirds of 50 per cent of the home will own part of an asset not producing income or capital until the death of the second spouse. Our three children will then have equal ownership of the home and decide what to do with it. All three of them are happy with this arrangement.
This approach appears to be the only way to benefit from the enhanced nil-rate band, particularly on the second death.
But can the £175,000 residence nil-rate band (RNRB) be claimed after the first and/or second of our deaths? And are there any inheritance tax (IHT) or income tax implications if after one of us dies the surviving spouse and child continue to live in the home and don’t pay rent to the beneficiaries of the deceased spouse?
Craig Harman, partner at Perrys Chartered Accountants
The RNRB is an additional IHT-free amount that was first introduced in 2017. The primary purpose of the additional allowance is to allow individuals to pass on the family home to the next generation free of IHT.
During the 2022-23 tax year, subject to meeting the relevant conditions, each taxpayer could have a further £175,000 allowance in addition to the existing £325,000 nil-rate band.
As a result, it's possible for each taxpayer to have £500,000-worth of assets, or £1mn for a married couple, before their estate is subject to IHT.
To qualify for the additional £175,000 allowance, the basic conditions are:
- The deceased individual must own a residence that they have lived in.
- This residence must be closely inherited by a direct descendant on death.
- The value of their estate must be below £2mn.
There are further rules that enable an estate to benefit from the additional threshold if the property has been sold prior to the date of death, for example to fund care costs.
It is only possible to qualify for the full £175,000 RNRB if the estate includes a residence of at least this value.
The maximum amount of RNRB that can be claimed is the lower of:
- The value of the qualifying residential interest, which is closely inherited; or
- The amount of the residential enhancement, which is £175,000 for the 2022-23 tax year.
For example, if the qualifying property is worth £150,000, this is the maximum that could be claimed.
If the value of an estate exceeds £2mn, the RNRB is reduced by £1 for every £2 above £2mn. For example, an estate worth £2.1mn would result in a reduction of £50,000, meaning only £125,000 can be claimed.
In the case of a married couple, the RNRB is transferable in the same way as the existing nil rate band. So if all assets are left to a spouse on the first death this would be covered by the spouse exemption, meaning that the RNRB is unused and £350,000 could be claimed on the second death. But different rules may apply if either spouse is not domiciled in the UK.
Regarding your specific questions, if 50 per cent of the property is left to a direct descendant on the first death, subject to meeting the other conditions, the RNRB band would be available. And if the remaining 50 per cent is left to direct descendants on the second death, a further £175,000 could be claimed, subject to meeting all conditions.
And as long as 50 per cent of the property is transferred on the death of the first spouse rather than during a lifetime, there wouldn’t be a requirement to pay rent.
However, there are a few possible tax and practical issues if you pass on the property in this manner. If the value of the property increases between first and second deaths, the two children not living in the property could be subject to capital gains tax on any sale of the property following the second death.
Also, if 50 per cent of the property is valued in excess of £175,000 this would use some or all of the standard nil-rate band on the first death. For a high-value property, this could create an IHT liability on the first death. This could also result in the joint estate losing out on any possible increase to the standard nil-rate band and/or RNRB.
Owning a 50 per cent interest in the property could have other tax implications for the beneficiaries. For example, additional stamp duty land tax liabilities on any purchase of their own homes.
I suggest getting some legal advice for the benefit of the remaining spouse and child. For example, what would happen if the other beneficiaries sell the property or charge rent? Or what would happen if they are declared bankrupt or die first while owning an interest in the property?
An alternative option would be to leave the property to the other spouse on the first death and children on the second death.
If the combined estate is worth more than £2mn, there may be a tax benefit in leaving part of the property on the first death. However, if the total estate is worth less than £2mn, it is likely to be more effective to leave the property to the other spouse on the first death. When the second spouse dies, a claim can be made for the full £350,000 RNRB, subject to the conditions set out above.
