Synopsis: An analysis of the draft clause on ‘downsizing’ and the new residence nil rate band included in draft Finance Bill 2016. The measure will apply for deaths from 6 April 2017 where the downsizing move or disposal occurred on or after 8 July 2015.
The draft Finance Bill clauses published on 9 December includes further detail on the ‘downsizing’ provisions announced at Summer Budget 2015. Broadly, the measure ensures that an estate will not be prevented from benefiting from ‘residence nil-rate band’ linked to a former property with a higher value where an individual either downsizes to a lower value home or sells (or otherwise disposes of) a qualifying residence on or after 8 July 2015, provided that other assets of an equivalent value to the ‘lost’ residence nil rate band are left to direct descendants (‘closely inherited’).
A technical note on the proposals was published for consultation in September 2015 and the issues raised have, according to HMRC, been taken into account in the draft legislation which has now been published in a Schedule to clause 44 of Finance Bill 2016. The Schedule amends new sections 8D-8F IHTA 1984 (introduced by Finance (No. 2) Act 2015) and introduces new sections 8FA-8FE which provide that a person’s estate will benefit from a downsizing addition where prior to death (but on or after 8 July 2015) the deceased had:
• Either downsized to a less valuable residence or sold or otherwise disposed of a qualifying residence – so that the full residence nil rate band (RNRB) can no longer be claimed; and
• Left either the lower value residence (or an interest in it) or some other assets to direct descendants on their death.
Note that in cases where RNRB has been lost as a result of a downsizing move, it is not necessary for the new residence to be closely inherited in order for the estate to qualify for the downsizing addition – the addition will be available even where the new residence is left to someone else provided that some other assets are closely inherited. However, in such cases, the amount of the downsizing addition will be limited to the lower of the amount of RNRB lost as a result of the downsize or other disposal, and the value of the property or other assets being closely inherited.
The downsizing addition must be calculated in percentage terms with the percentage of RNRB lost by reason of the downsizing or other disposal being applied to the person’s default allowance at death to determine the lost relievable amount. The precise formula for calculating the residence nil rate amount is complicated but in simple terms the lost (additional) RNRB is calculated via a four-step process:
1. Calculate the percentage of the then available RNRB that the individual could have claimed had they died at the time of disposal of the former residence.
2. Calculate the percentage of the currently available RNRB that the individual is actually able to claim on death.
3. Calculate the difference between these two percentages
4. The lost RNRB is the resulting percentage multiplied by the RNRB that the individual is otherwise able to claim on death.
This amount (or, if lower, the value of the closely inherited assets) is added to the RNRB that would otherwise have been available (taking account of any amount carried forward under the transferable nil rate band rules) to determine the total amount of RNRB available to the estate.
While HMRC are yet to update their technical note to include detailed examples of what this will look like in practice, we would envisage the new rules operating as follows:
Example 1 – downsizing
Shirley’s husband, Tom, died in January 2014 leaving his entire estate to Shirley. In September 2015, Shirley sold the property in which she and Tom had lived together prior to his death for £400,000 and purchased a smaller property for £199,950. Shirley dies in May 2020, leaving her estate worth £415,000 to her children. At the date of her death, the property that Shirley owns is valued at £210,000. As Shirley’s situation meets the conditions outlined in new s8FA – 8FE IHT Act 1984, her estate will qualify for the downsizing addition which is calculated as follows:
Step 1: Percentage of RNRB that would have been used if Shirley had died at the point that the more valuable property was sold = 400,000/200,000* = 200%. Note that the rules provide that where this figure is greater than 100%, the percentage should be taken as 100%.
Step 2: Percentage of RNRB used at date of death = 210,000/350,000 = 60%
Step 3: Percentage of RNRB lost by reason of downsizing = 40%
Step 4: Lost relievable amount = 40% x 350,000** = 140,000
The downsizing addition is therefore £140,000 (as this figure is lower than the amount that is being closely inherited). This downsizing addition must then be added into the calculation required by s8E IHTA to determine the residence nil rate amount. This has the effect of increasing Shirley’s residence nil rate amount to £350,000 (which is what it would have been under the transferable nil rate band rules had she still owned the original, higher value residence at the date of her death).
* the new clause provides that where the property was sold before 6 April 2017, the residential enhancement should be taken to be £100,000
** the percentage lost by reason of downsizing is applied to the deceased’s default allowance as defined in the primary legislation. This is essentially their residence nil rate amount taking account of the transferable nil rate band rules. Note that where first death occurred before 6 April 2017, a 100% uplift is always given.
Example 2 – disposal
Barry sells his home worth £275,000 in May 2020 following a move into residential accommodation. At the time of the sale the available RNRB is £175,000. Barry dies two years later leaving his estate of £450,000 to his children in equal shares. For simplicity we will assume the RNRB is still £175,000 at the date of death.
Barry’s lost relievable amount is calculated in accordance with a two-step process as follows:
Step 1: Percentage of RNRB that would have been used if Barry had died immediately before disposing of the property = 275,000/175,000 = 157%. As before this figure is restricted to 100%.
Step 2: Apply this percentage to Barry’s default allowance, so 100% x £175,000 = £175,000
The downsizing addition is the lower of the lost relievable amount and the amount of the estate being closely inherited i.e. the lower of £175,000 and £450,000. This is Barry’s residence nil rate amount. Barry also has a standard nil rate band of £325,000 to offset against his estate and consequently no IHT is payable.
Other points worthy of note are that:
• the additional RNRB will be tapered away in the same way as the RNRB if the value of the estate at death is above £2m
• the additional RNRB will be applied together with the available RNRB but the total for the two will still be capped so that they do not exceed the limit of the total available RNRB for a particular year
• a claim must be made for the additional RNRB in a similar way that a claim is made to transfer any unused RNRB to the estate of a surviving spouse or civil partner
While the broad result of the measure is clear: an estate will remain eligible for such proportion of the RNRB as is foregone as a result of downsizing or disposal of a property prior to death – the reality is that the downsizing clauses run to some 8 pages which are difficult to negotiate and contain some anomalies on which clarification will be required before the Finance Bill becomes law.
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