Inheritance tax changes: Untangling the Finance Bill 2015

Freedom to leave your family home to your children, along with a £1m threshold for inheritance tax (IHT) – a Conservative target for years – are two political factors driving the big summer Budget change on main homes.

The draft provisions in section 9 of the Finance Bill 2015, published on 15 July, comprise nine pages: this is horrendously complicated legislation, which may well be amended before the Finance Act is passed this autumn.

The following is an outline of the provisions relating to the increased nil rate band (NRB) where homes are inherited by descendants:

• Larger estates can be left free of IHT where there is a qualifying residential interest, which includes a life interest in a trust amounting to a pre-22 March 2006 interest in possession (IIP) or an immediate post-death interest (IPDI) – (see the definition of ‘estate’ in section 5 of the Inheritance Tax Act 1984);
• ??The residence nil rate amount – from the residential enhancement – will apply for deaths from 6 April 2017, initially (as it is phased in) at £100,000 for the tax year 2017/18, increasing to £125,000 in 2018/19, £150,000 in 2019/20, and £175,000 in 2020/21;
• In 2020/21, when the NRB will still be frozen at £325,000, this will bring the total tax-free amount to £500,000, or potentially £1m for a married couple (including civil partners);
• Thus in five years’ time we get to that magic £1m. The price for this generous provision is the freezing of the main NRB for a total of 12 years. It has already been kept at £325,000 for seven years, since increasing in the tax year 2009/10;
• Homes are left to descendants by the property interest being closely inherited, which includes leaving it in an IPDI, a disabled person’s interest, a bereaved minor’s trust, or an 18-25 trust. A very broad definition includes stepchildren, foster children, and even natural children who have been adopted (disregarding the normal rule). Whether the home is kept or simply sold at the first opportunity does not matter;
• A tapered withdrawal applies if estates are over £2m. Losing £1 for each £2 over that threshold, the residential enhancement is completely lost for estates over £2.2m in 2017/18, or over £2,350,000 in 2020/21. The figures do not take into account reliefs or exemptions. Even if the whole estate goes to a surviving spouse, with a full spouse exemption, and the figures then inflate the second estate, this makes no difference;
• Estate for tapering purposes includes any aggregated trust interests (pre-22 March 2006 IIPs or IPDIs), but seemingly does not take into account lifetime gifts caught in the calculation of IHT on death;
• Where a spouse dies before 6 April 2017 there is a £100,000 residential enhancement, subject to tapering over the £2m threshold. An estate of £2.2m plus will mean there is no brought-forward allowance. So, helping to manage client expectations, if one spouse with such an estate has already died, there will be no carry forward from the first spouse if the second spouse dies after 5 April 2017;
• Lifetime gifts are in an unusual position unless changed, with positive and negative aspects. On the one hand, gifts, even if taxable on death, are not included in the estate and thus cannot benefit from this residential enhancement. So, gifting a property interest to your children, for example, within the provisions for shared accommodation avoiding a reservation of benefit, loses the benefit of this residence nil rate amount. If the gift is taxable, it will not be relieved for IHT on death, so we need to rethink strategies for lifetime gifts of property. On the other hand, if taxable lifetime gifts are not taken into account in the £2m threshold for taper relief, it would be worth considering lifetime gifts of other assets to reduce an estate below £2m, even on a death bed; and
• If an estate includes more than one property, the person can nominate which is the qualifying residential interest. If one of those properties is owned in trust, the trustees have no say in this choice, which is quite different from capital gains tax principal private residence relief, where a joint election is required. SJ

 John Bunker is head of private client knowledge management at Thomas Eggar