Helping you prosper
If your home is larger than you currently need, downsizing could free up capital, reduce your running costs and make everyday life easier. You may also be considering selling your home before moving into rented accommodation or residential care.
Before making any decisions, it is important to understand how selling, gifting or downsizing your home could affect your estate's Inheritance Tax (IHT) position.
Current Inheritance Tax allowances
IHT is not payable if the value of your estate is below £325,000. Likewise, if you leave everything in your estate, which exceeds the £325,000 IHT threshold, to your spouse, civil partner, charity or community amateur sports club, no IHT is payable.
If you are married or in a civil partnership, any unused percentage of this allowance can usually be transferred to your surviving spouse or civil partner. This could provide a combined nil-rate band of up to £650,000.
An additional residence nil-rate band (RNRB) of up to £175,000 may also be available when a qualifying home is left to direct descendants. These can include children, grandchildren, adopted children, foster children and stepchildren. This can increase your overall IHT threshold to £500,000.
Subject to the relevant conditions, a married couple or civil partners could potentially pass on an estate worth up to £1 million without IHT. However, this will depend on the value of the home, the overall estate, who inherits the property and whether both sets of allowances are available.
At the moment, the standard nil-rate band is fixed at £325,000 and the RNRB at £175,000 until 5 April 2031.
As property, pension and investment values rise while these thresholds remain frozen, more estates could potentially fall within the scope of IHT.
Will downsizing mean losing the residence nil-rate band?
Not necessarily. The RNRB normally applies when someone leaves a qualifying home, or a share of it, to their direct descendants. Only one residential property can qualify, and the deceased must have lived in it at some point. A buy-to-let property in which the deceased never lived will not normally qualify.
To benefit from RNRB, you do not have to own a property at the time of your death. If you decide to downsize to a smaller and less valuable property or dispose of your property and move into rented accommodation/residential care, you could lose some or all of your RNRB in the process.
Special rules may preserve some or all of the RNRB, which are known as the "downsizing addition".
How does the downsizing addition work?
The downsizing rules can apply where a home was sold, gifted or replaced with a less valuable property on or after 8 July 2015.
Broadly, the former property must have been a home that could have qualified for the RNRB if you had continued to own it. Direct descendants must also inherit sufficient assets from your estate.
The actual calculation can be complicated. The amount available will depend on factors including:
- the value of the former home
- the date it was sold or gifted
- the value of any replacement home
- the maximum RNRB available at the date of death, and
- the value of the assets passing to direct descendants.
The downsizing addition cannot exceed the RNRB that would otherwise have been lost.
What happens if your estate is worth more than £2 million?
The RNRB starts to reduce when the net value of an estate exceeds £2 million. It is withdrawn at a rate of £1 for every £2 by which the estate exceeds that threshold.
For example, an estate that is £100,000 above the threshold would lose £50,000 of its available RNRB.
Importantly, the calculation is based on the estate's value before certain exemptions and reliefs are taken into account. This is known as Taper Relief.
Downsizing may reduce your property's value, but if the sale proceeds remain in your estate as cash or investments, your estate's overall value may not have fallen.
What if you give your home away?
Gifting your home during your lifetime does not necessarily remove it from your estate for IHT purposes.
If you give your home away but continue living there without paying a full market rent and your share of the bills, it may be treated as a "gift with reservation of benefit". This generally means the property remains part of your estate for IHT purposes.
If you give your home away, move out and survive for at least seven years, the gift will normally fall outside your estate for IHT purposes. Different rules can apply if you continue to benefit from the property.
Gifting a home can also have wider tax, financial and care-fee implications, so advice should always be obtained before transferring ownership.
A future change involving pensions
From 6 April 2027, most unused pension funds and pension death benefits will be included within a person's estate for IHT purposes. Death-in-service benefits payable from registered pension schemes will generally remain outside the new rules.
Personal representatives will be responsible for reporting and paying any IHT due on the pension assets.
This change could increase the value of some estates above the £2 million RNRB taper threshold, reducing or removing the available residence allowance. It is therefore increasingly important to consider your home, pensions, investments and other assets together when reviewing your estate.
Keep appropriate records
You do not need to notify HMRC when you downsize, sell or gift your former home. However, you should retain documents showing:
- when the property was sold or transferred
- its sale price or market value
- details and values of any replacement home, and
- how the proceeds were used.
Your personal representatives will need this information to calculate and claim any downsizing addition after your death.
The claim must normally be made within two years of the end of the month in which the death occurred. HMRC can extend this deadline in some circumstances.
Planning ahead
Downsizing does not automatically mean losing the RNRB. However, the rules are detailed and the forthcoming changes affecting pensions could alter your estate's overall IHT position.
At UHY Peninsula, we can review your property, pensions, investments, family circumstances and will to help you understand your potential exposure and plan appropriately.
If you are considering downsizing, moving into residential care or gifting your home, please get in touch with Mel Stone, partner at UHY Peninsula on 01566 777189 or email enquiries@uhy-peninsula.com to arrange a complete Inheritance Tax review.
