How to avoid Inheritance Tax on your property
Residential Nil Rate Band (RNRB) which was introduced in April 2017 means that couples with a home worth up to £1 million will be able to pass it on to their direct descendants IHT free. The simplest method may seem to be to gift your home to your children. Simple, but fraught with danger as should your children get divorced or become bankrupt you may lose your home as part of a legal settlement.
Gifting property to avoid Inheritance Tax
Estates up to £1 million
At the moment, the first £325,000 of a person’s estate is free of IHT which is known as the Nil Rate Band (NRB is also known as the Inheritance Tax threshold). The Residential Nil Rate Band (RNRB) means you get an extra chunk free of IHT if you own a home (up to £175,000 per person). Same as NRB, RNRB is transferable on spouses or civil partners death.
Families with estates up to £1 million can avoid IHT as each parent will have a NRB of £325,000 and a RNRB of up to £175,000. If you are not owning property, you’re not entitled to RNRB.
Estates over £2 million
For estates worth over £2 million, the Residential Nil Rate Band will be progressively tapered away by £1 for every £2 that the total estate exceeds the taper threshold. This means that there will be no RNRB available for estates over £2.2M.
Please note that reliefs (Business Property Relief and Agricultural Property Relief) are not included in the calculation of the estate value.
The five areas of the most common misunderstandings about Residential Nil Rate Band (RNRB)
There have been misunderstandings about the RNRB which could lead people to structure their finances in the wrong way. Please see the most common misunderstandings below:
1. You can select which property the allowance is set against
The Residential NRB can be used against any property within or outside of the UK which was used as your own home and lived in by you. However, the value of the property must be included within the person’s estate for IHT reasons.
2. The allowance can still apply even if the property has already been sold
This means that if you have downsized you will not be penalised because the allowance can then be used within your estate against the value which the property was sold for.
3. Any outstanding mortgage is deducted before the allowance is added
The value of the home is calculated by subtracting the liabilities secured on the home from the market value of the property, all for RNRB reasons.
4. The allowance can only be used when the property is left to direct descendants
The home/value of the home must be inherited by your child or grandchild for the RNRB to be eligible; this does not include siblings, any other members of the family, other people or trusts.
5. The allowance of a previously deceased spouse is available on the second death of the surviving spouse irrelevant of when the first spouse died
This is only available provided all of the previous points are adhered to.
Proportional property gifting to avoid Inheritance Tax
You could gift a proportion of your home but there would be a same problem as gifting your entire home to children (should your children get divorced or become bankrupt you may lose your home as part of a legal settlement) but not quite as risky.
Capital Gains Tax
In addition, you will have to pay rent at a commercial rate on the proportion given away to satisfy the HMRC that a gift has actually been made in reality. Capital gains tax will also be payable by your children on the gain in the proportion gifted to them.
If you gift part of the house in your early 70’s the capital gains tax bill could be large. However, there are better methods.
Depending on the value of the house and the value of the estate we can suggest different methods of mitigating the tax.
Yes, the methods involved can be quite complex but let’s face it you are trying to legally avoid tax. HMRC is not going to make it simple to do otherwise everyone will do it.
Other Ways to avoid IHT on your property
1. Property Gift - A Gift of Reservation
A gift of property made by a person on or after the 18th March 1986 is called a gift of reservation (GWR) as long as the person is still benefiting from the property, IE they are still living in it. If this benefit is reserved, then it will be included as a part of the gift givers estate for inheritance tax purposes, even if they no longer own the property, they are still using it for their own benefit.
When talking about a GWR, a gift can mean a sale which was made deliberately below the market value of the property.
For example, if a property was worth £1 million and a person sells it for £750,000. The transfer is part sale and part gift meaning the £250,000 loss to the estate would be treated as a potentially exempt transfer and would be included in the deceased’s estate if they pass within 7 years of the sale, even if they didn’t receive any benefit from the transfer.
The GWR rules have only been around for 40 years meaning if someone placed an investment in a trust before the 18th March 1986, they will not get caught unless further gifts are made on or after that date.
The use of these GWR rules by HMRC means it is very important to ensure that any gifts or loans made to adult children or anyone else are properly recorded as failure to do so could have them fail for IHT purposes.
You can put your house in a trust to avoid Inheritance Tax as trusts do not have to be expensive. Our trusts range from £300 to £5,200 depending on the type of trust arrangement you have and the purpose of it.
If you ensure that any of your assets that potentially exceed the Inheritance Tax Allowance are transferred to a trust at least seven years before the death of either you or your surviving spouse, these assets will not be liable to Inheritance Tax.
Trusts and the legal wording involved is a very complex area and therefore experienced legal professionals with whom we work with closely should always be employed in this respect.