The Inheritance tax residence nil rate band – again

Once again we return to the subject of the residence nil rate band (RNRB), arguably the most important Inheritance tax (IHT) development for clients since the introduction of the transferable IHT nil rate band for married couples and civil partners in 2007.

The RNRB provides an entitlement to an additional nil rate band of £175,000 when fully in force in 2020/21 provided all the necessary conditions are met.

In brief, these are that your estate contains an interest in a dwelling house which you have at some point occupied (“a qualifying residential interest”), and that that qualifying residential interest is inherited (by Will, on intestacy, or otherwise) by a lineal descendant. Unlike the general nil rate band, the RNRB is dependent on the identity of the beneficiary who inherits the property; this is a concept that is unusual in modern UK succession tax, where, aside from the surviving spouse exemption, the relationship of the recipient of the gift to the deceased person is usually irrelevant. Entitlement to the allowance is also reduced once the value of an estate exceeds £2 million, becoming worthless once an estate exceeds £2.35 million when the allowance is fully in force (assuming the deceased cannot carry forward any allowance from a previously deceased spouse or civil partner).

Some changes to the original draft legislation creating the RNRB were made by the Government last week. Previously, the definition of lineal descendant incorporated a deceased person’s children, grandchildren and other direct descendants as well as step-children, adopted children and foster children. This has now been extended to encompass the spouse or civil partner, or surviving spouse or civil partner (who has not re-married), of lineal descendants.

Amendments also make it clear that if the qualifying residential interest is left to a disabled person’s trust for a lineal descendant, that RNRB can be claimed whatever the type of the disabled person’s trust. On the subject of gifts to trusts, it has been pointed out in the media recently that legacies of qualifying residential interests to discretionary trusts are not closely inherited within the terms of the draft legislation, even if all the potential beneficiaries of the trust are lineal descendants. Given the inherent flexibility of discretionary trusts this is unwelcome.

It should be remembered, however, that if an appointment out of a discretionary trust is made within two years of the deceased’s death, this is read back to the date of death for IHT purposes. This means that, under the current law, if your Will incorporates a discretionary trust of residue on the second death, an appointment out of part or all of the qualifying residential interest to a lineal descendant (or a life interest trust for their benefit) within two years of death should enable the RNRB to be claimed retrospectively. The rest of your estate would then continue to benefit from the flexibility of the discretionary trust and the fact that it can be used as a tax planning vehicle for future generations.

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