No-one likes to think about inheritance tax.
We don’t actually have to pay it – but our loved ones will. The wealth we pass on to them when we pass away ourselves is cut down by it.
And at 40% of everything over the £325,000 threshold, the taxman could be helping himself to quite a large cut.
The rising cost of property means that almost anyone who owns a home is likely to be subject to Inheritance tax, or IHT. But there is some good news.
The first piece of good news
The inheritance tax threshold – technically known as the nil-rate band – has been frozen at £325,000 for years, allowing HMRC to rake in record amounts from ordinary people with a tax that was supposed to only catch the rich.
It would mean that there would be little chance of passing on a family home to the next generation, even if they lived in it, because duty would need to be paid.
Fortunately, to prevent this injustice, in 2007 the then Chancellor, George Osborne promised to raise the IHT threshold to £1m and “take the family home out of inheritance tax”. Things did not go entirely to plan, but the family home allowance – or residence nil-rate band – is the result. It means that with some limitations, you can now claim an additional £175,000 nil-rate where you pass your home on to your direct descendants at your death. This includes your children and grandchildren, a stepchild or foster child.
So you can pass on a home worth £500,000 without being hit by inheritance tax. Everybody is entitled to the main nil-rate band. What’s more, on the first death of a married couple, the unused proportion of any relief can transfer to the survivor. This applies whenever the death of the first spouse occurred, since 1975. For civil partners, the same allowance applies except that the first death must have occurred on or after 5 December 2005, the date the Civil Partnership Act became law in the United Kingdom.
This means that a home worth £1 million could be passed on without the taxman taking a share.
But many people have a large home when their family is living with them, and then cut the costs and the housework by downsizing when the children move on to homes of their own. What happens then?
The second piece of good news
Many people outlive their need for a large home and need to downsize. As the years go by, even a smaller home becomes too much and a care home becomes the only answer.
Perhaps surprisingly, those who have sold up can still benefit from the tax concession on their large property, even if they no longer own it.
This downsizing relief can apply if you owned your home on or after 8th July 2015 and subsequently sold it to downsize or to move into a care home. In practice this means that you could have a large cash sum to pass on to your children and grandchildren and be able to avoid IHT liability on the first £1 million.
A property does not have to remain as your home when you die. As long as it has been your home in the past, the relief can still apply.
Can your estate benefit?
Your beneficiaries or your executor will have to claim downsizing relief. It is not applied automatically, and as always with tax, there are some complications.
- The key requirements are that you had a property which was your home at some point after 8th July 2015 and was sold before you died.
- As with the nil-rate band, any unused family home allowance at the first death can also transfer to the surviving spouse, referred to as the “brought forward” allowance.
- The total value of your estate cannot be more than £2.7m.
- Relief is restricted where the whole estate, exceeds £2m. Above that amount the relief reduces at £1 for each £2 of the excess. It means that with a brought forward allowance from your spouse, estates above £2.7m will not qualify. This £2m threshold can be relevant at the first death as well because it could restrict the level of relief carried forward.
Getting some expert help
The rules about IHT are complicated. Getting things right could save your loved ones a great deal of money, getting them wrong could be costly – and getting some expert help is essential.
At Continuum we understand the intricacies of IHT, and we can help you develop a plan which will minimise the wealth lost to the taxman.
Having a succession plan in place means peace of mind for you as well as increased security for those you leave behind. Why not call us today?
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable inheritance tax strategy, you should seek independent financial advice before embarking on any course of action.
The Financial Conduct Authority does not regulate taxation and trust advice or will writing.
Levels and bases of and reliefs are subject to change and their value depends on the individual circumstances of the individual. We recommend that the individual seeks professional advice on personal taxation matters.