Tony Granger explains the inheritance tax implications of owning the family home and strategies to reduce the inheritance tax exposure.
Estimates are that inheritance tax (IHT) payable on taxable estates in 2019/20 will be over £6 billion. The family may not be fully protected from exposure to IHT.
IHT is payable at 40% on your taxable estate, after exemptions and allowable deductions. Taxable assets may include your share of the family home. In 2019/20, the basic nil rate band (NRB) is £325,000. To this may generally be added any unused NRB relief from the prior death of a spouse or civil partner.
If the family home is left to a direct descendant, another £175,000 can generally be added in the 2020/21 tax year, in the form of a residence nil rate band (RNRB). Total reliefs for a married couple could be £1 million.
However, if the estate is worth more than £2 million, the RNRB additional allowance reduces on a £1 for £2 basis until completely lost at £2.35 million.
There may be good reasons not to leave the home to direct descendants. For example, the home might be used for equity release to pay for care costs; you may not have direct descendants as couples could be childless; or the home is to be sold on death.
Strategies to reduce IHT on the family home
Here are ten possible IHT planning points to consider:
- Ensure that all available nil rate bands can be used. Consider leaving the family home to direct descendants. In 2020/21, a married or civil partnership couple will have up to £1 million worth of nil rate bands available between them.
- Ensure the family home does not have to be sold to pay IHT. Life assurance in trust can provide funds free of tax to pay IHT.
- If the family home is left to the children to use the additional residential nil rate band, they could then sell it if they require cash.
- Consider severing the tenancy if the home is owned jointly. On death, your share could be left in trust or passed to a nominated third-party instead of your spouse.
- Gift your home to others during lifetime, including children. Survive for seven years and the value of the gift is out of your estate (PET). However, if intending to stay rent-free, the gift will revert back to your estate on death (under the ‘gifts with reservation’ (GWR) rules), so pay a market rent.
- Sell the home and live there rent-free. Schemes include home reversion and equity release. The IHT value is the value at death, after the cost of home reversion or equity release.
- Take a loan (remortgage or equity release) and consider investing into a discounted gift trust (DGT) arrangement. A portion of the investment is immediately out of your estate; the balance is out after seven years. You receive a set income for life and live in your own home. This generally avoids the pre-owned assets tax (POAT) and GWR charges. On death, the value of the commercial loan reduces your estate, subject to the restriction that the amount of the loan must first be deducted from the value of the assets it was used to acquire, not the property it was secured on.
- Consider gifting the home to a trust. This is a chargeable event and lifetime IHT may be payable at 20% on value over the NRB value. However, the GWR or POAT rules may apply if you continue to live there rent-free.
- Think about passing your home share on death to trust with your spouse retaining a life interest ceasing absolutely on their death; the spouse can live there without the GWR rules applying.
- Leases: consider gifting the property then leasing it back at full market rent. However, beware the POAT rules, which could result in unexpected income tax liabilities.
Practical tip
Consider a full review of your estate with a view to reducing IHT and other taxes affecting the home. Thousands of pounds could potentially be saved by planning now. However, seek advice beforehand from a qualified tax professional.
