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Residence Nil Rate Band Trust & Taper Traps

Residence Nil Rate Band

The Residence Nil Rate Band (RNRB) came into effect in April last year and provides additional tax relief when passing on the family home to your children or remoter descendants.

For the tax year 2017/2018 the relief was worth an additional £100,000 for each parent. For the current tax year, the relief has increased to £125,000. This could be worth an additional £250,000 of tax relief for a couple in addition to an individual`s own nil rate band of £325,000. The relief will increase to £150,000 for tax year 2019/2020 and £175,000 for tax year 2020/2021.

With careful planning, a couple could pass assets up to £1million to children without paying any inheritance tax by 2020/2021. 

RNRB is only available where the main residence passes to children (including adopted, foster or step children) or linear descendants (grandchildren) on death.

There are many traps for the unwary, but this article concentrates on two areas that are often overlooked but could be corrected by careful review during your lifetime.

The Discretionary Trust Trap

A discretionary trust is often included in a will to achieve maximum flexibility for trustees to consider the distribution of assets within a defined class of beneficiaries, without any legal obligation to pay income and capital to any particular beneficiary (if it is not appropriate to do so).

Unfortunately, the additional tax relief of a RNRB will be lost if property is placed in a discretionary trust for the benefit of children or grandchildren. 

RNRB still applies to Bereaved Minor Trust, 18-25 Trusts or Disabled Persons` Trusts.

A trust which provides a right of residence in property, or a full life interest (a right to reside and a right to receive income), are treated as an interest in possession trust and the RNRB can still be claimed. Therefore, if your will includes a discretionary trust it is important to review the will and consider if this type of trust is still required even though it is disqualified from claiming the additional RNRB.

The Taper Trap

The taper relief provisions mean that the RNRB will be reduced by £1 for every £2 that the deceased`s estate exceeds £2million. This means that for the current tax year there will be no RNRB available if the estate has assets of more than £2.25million.

By 2020/2021 the entire RNRB will be eroded if the estate exceeds £2.35million.

Consider a married couple (or civil partnership) with assets that include a large property. Many couples hold the family home as joint tenants. On the first death, the family home passes to the surviving spouse and is covered by the spouse exemption. No inheritance tax is payable. 

Although the RNRB is not used on the first death, the unused RNRB can be transferred to the estate on the second death. Depending on the size of the survivor`s estate, which has now been aggregated with the estate of the first spouse, this transferable RNRB and transferable nil rate band may be sufficient to cover any tax liability.

However, this `bunching` of the estates of both spouses on the second death may result in the undesirable consequence of losing the RNRB relief if the combined estates exceed £2.25million.

Taper relief may mean that £250,000 of assets are exposed to an additional inheritance tax charge of £100,000.
 
What can be done to preserve the relief?

One option is to consider converting ownership of property from joint tenants to tenants in common. By holding the beneficial interest as tenants in common, each spouse can pass their share by will (for example, to children or grandchildren) and use the RNRB. This would also benefit by reducing the value of the survivor`s estate. 

The spouse could also pass assets to beneficiaries (other than the surviving spouse) up to the value of the prevailing nil rate band of £325,000.

By reducing the value of the survivor`s estate below £2million the availability of RNRB is preserved.

Summary

It is important to regularly review your existing will and take advice from the private client team at Rutherfords LLP.

In particular, we can consider with you the tax consequences of including a discretionary trust in your will, how the taper relief may erode the availability of RNRB, and the merits of holding property as tenants in common.

Tony Illsley LL.B
Partner & Head of the Private Client Department
Panel solicitor for the Midlands Air Ambulance Charity

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