How to Save Inheritance Tax by Using the Family Home

7 September 2023

Jan Friend

Reducing Tax, Estate Planning / IHT

In the fourth and final part of this series, we look at using the family home as a way of saving inheritance tax on your estate.

Inheritance tax (IHT) is a subject that concerns many families.

It is a tax levied on the value of an individual’s estate upon their passing and can significantly impact the wealth left behind for loved ones.

IHT and The Family Home

Quite often the one valuable asset in an estate is the family home.

In this blog, we will explore some strategies and considerations to maximise inheritance tax savings using the family home.

Understanding Inheritance Tax

Inheritance tax (IHT) is a levied on the estate (property, money and possessions) of a deceased person, including certain gifts made during their lifetime.

The current threshold for an individual, called the nil rate band, is £325,000.

If your spouse dies before you and does not use all of their nil rate band the excess can be transferred to your estate.

In addition there is a further threshold, known as the residence nil rate band (RNRB), see below.

Essentially if your estate is worth more than the available nil rate bands, it may be subject to IHT at a rate of 40%.

Utilise the Residence Nil-Rate Band

The residence nil-rate band (RNRB) is an essential tool in reducing inheritance tax liability concerning the family home.

It can save £70,000 in IHT for an individual, and £140,000 for a couple.

However there are strict rules for when it can be claimed which are important to know:

It only applies to a home where the deceased has been living. It applies to a holiday home but not a rental property.
It is only available on legacies to direct descendants, such as children or grandchildren. This includes stepchildren but not nieces and nephews.
It is only available in full for estates worth £2million or less. There is a partial allowance for estates between £2 and £2.7million.

Downsizing allowance is available in certain circumstances.

It applies when you sell a property that qualifies for the RNRB, and you subsequently downsize or cease to own a property.

In such cases, provided you owned your original home on or after 8 July 2015, you may still be eligible to claim RNRB based on the value of your original home.

Consider Making Lifetime Gifts

As mentioned in our previous blog making lifetime gifts can be an effective way to reduce the value of your estate and thus lower the potential inheritance tax liability.

One such method is to gift the family home to direct descendants, either outright or through a trust.

However, there are important considerations to bear in mind when making gifts, as some gifts may still be subject to inheritance tax if the donor passes away within seven years of the gift.

You have to be careful if you gift away assets but still enjoy some benefit from them – such as if you give away title to your home but remain living there – such a gift will not work for IHT purposes.

You can get around this by paying market rent for occupying the property, or by gifting to an adult child who lives with you.

Setting Up a Trust

Using a trust can be one way to preserve the family home and potentially minimise inheritance tax.

A trust allows you to put assets, including the family home, under the care of appointed trustees for the benefit of specified beneficiaries.

This can be an effective way to retain control while reducing the overall value of your estate for tax purposes.

However, as with an outright gift if you want to remain living in the home you would need to pay market rent to the trust for the tax planning to work.

More common is for the first spouse to pass away to put their half of the house into a discretionary trust via a provision in their Will.

This has the advantages of inflation proofing the half share, so that when the second person passes away their estate will pay less tax provided property prices have increased and also ensures that your half of the property always goes to your beneficiaries and avoids the risk of this not happening if your spouse gets remarried.

As an example:

John passes away with a half share of the family home worth £1 million in full.

He and his wife Margaret held the property as tenants in common and in his Will John left his half of the house to a discretionary trust in favour of the couple’s daughter and grandchildren.

Margaret passes away eighteen years later leaving her share of the house to her daughter outright when the property is worth £1.5 million.

The IHT payable is:

Margaret’s half share of the home £750,000

Nil rate band £325,000

Residence nil rate band £175,000

Transferable RNRB £175,000

Taxable estate £ 75,000

Tax payable £ 30,000

If John had left his whole estate to Margaret the tax payable on her death would have been:

Margaret’s full share of the home £1,500,000

Nil rate band £325,000

Transferable nil rate band £325,000

Residence nil rate band £175,000

Transferable RNRB £175,000

Taxable estate £500,000

Tax payable £200,000

The tax saving in this example is £170,000!

Joint Ownership

For married couples or civil partners, jointly owning the family home can be advantageous for inheritance tax planning.

By owning the property jointly as “tenants in common,” each partner can leave their share of the home to beneficiaries, potentially making use of their individual inheritance tax allowances – see the example above.

Summary

The family home can play a vital role in inheritance tax planning, and there are several strategies that can be employed to maximise tax savings.

Utilising the residence nil-rate band, considering lifetime gifts and trusts and jointly owning the property are all valuable options to explore.

Nevertheless, inheritance tax rules can change over time, and the intricacies involved can be challenging to navigate alone.

Therefore, it is essential to seek advice from professionals to create a comprehensive and effective inheritance tax plan that meets your unique needs and protects the financial legacy you wish to leave for your loved ones.

Getting in touch with us

If you are interested in finding out how we can help you reduce inheritance tax on your estate or that of a family member contact Jan Friend by email or on 01634 731390.