If you choose to downsize to a cheaper property or sell your home to pay for care, you may worry you’ll lose valuable inheritance tax (IHT) allowances.
More than six million adults are thinking about or planning to downsize at some point in the next four years, according to analysis by Suffolk Building Society.
But experts say the ability to claim inheritance tax relief based on the value of your previous home, known as downsizing relief, is not widely known – which could result in a higher than necessary tax bill levied on your estate when you die.
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What is the residence nil rate band?
Inheritance tax is only payable on estates valued over £325,000 thanks to a tax-free allowance called the nil rate band.
On top of that, the residence nil rate band (RNRB) gives qualifying homeowners the opportunity to pass on up to £175,000 of their home’s value as a further tax-free allowance. This means the threshold above which inheritance is charged could jump to £500,000.
Both these allowances are transferrable between spouses. For example, if Mr Jones dies first and he hasn’t used his nil rate and residence nil rate bands, he can pass them to Mrs Jones. On her death, Mrs Jones’ estate will be inheritance tax free up to £1 million. Above this, it is taxed at 40%.
Who qualifies for the residence nil rate band?
To be eligible for the extra relief to boost your IHT-free allowance there are certain qualifying factors you must meet:
- You must have died on or after April 6, 2017.
- Your property, or a share of it, must be left to a direct lineal descendant defined as children, stepchildren, adopted children or grandchildren.
- You must have lived in the property at some point, which rules out buy-to-lets.
Jessica Graham, solicitor, private client department at Brabners Personal, said: “Some of my clients have two properties that they’ve lived at some point and ask which one they should claim the residence nil rate band against. In this case, the executors get to choose and it can’t be claimed against both.”
The property the executors choose is usually the most valuable, to maximise the RNRB benefit.
For estates more than £2 million, the RNRB will reduce by £1 for £2 over the £2 million threshold.
Consequently, this means no RNRB is available at all for an individual’s estate with a value of more than £2,350,000 or £2,700,000 for couples.
When pensions become liable for IHT from 6 April 2027, more households could wind up losing their RNRB.
What is downsizing relief?
Normally, you can pass on up to £175,000 of your home’s value inheritance tax–free through the residence nil-rate band.
Downsizing relief, also known as downsizing addition, can protect people who sell or move out of their home later in life from losing the full RNRB that they may have been entitled to if they’d stayed in their previous home. There are no restrictions on why you might be downsizing to qualify for the relief.
“It was recognised that people who were downsizing or moving into care would lose the resident’s nil rate band altogether which the government sees as unfair,” said Graham.
“They don’t want Mrs Smith staying in an £800,000 property for the sake of not being able to claim this tax-free allowance, they want her to be able to move to a more suitable property which means that home becomes available for someone else.”
The name downsizing relief is slightly misleading, however, because it applies even if you no longer own a home at all because you sold your property to move into a care home to either pay for your care or because you didn’t want the hassle of renting it out.
To be eligible, the person who has died must have sold, given away or downsized to a less valuable home on or after 8 July 2015.
How downsizing relief works
If you’ve downsized to a cheaper property that’s worth less than £175,000 or, the share you own in your current property that you plan to leave to direct descendants is worth less than £175,000, you can apply for downsizing relief.
The relief will bridge the gap between the amount of RNRB you are entitled to in your current property and what you have been awarded had you still lived in the more expensive house.
Imagine a couple who sold a £400,000 home and moved into a flat worth £250,000.
When they eventually pass away, their estate is worth £900,000 in total, including the new property and other savings.
Had they stayed in the more expensive property, they would have been entitled to combined RNRB allowances of £350,000.
The couple is entitled to a £325,000 inheritance tax-free allowance each.
Sitting above this combined nil-rate tax band of £650,000, the couple’s estate is potentially facing an IHT liability unless they make full use of their RNRB.
Based on the value of the flat they wish to leave to their children, without downsizing relief, their combined RNRB would be capped at £250,000.
But under the rules of the relief, the executors can claim a £100,000 downsizing addition, given the value of their previous home was £400,000. This ensures the couple’s estate still benefits from the full £350,000 residence nil-rate band available.
By claiming the full residence nil-rate band, there’s the opportunity to avoid inheritance tax completely.
'I've moved into a care home. Will our inheritance tax allowance be cut if we sell our home?'
You will not automatically lose your some of your inheritance tax allowances if you sell your home after moving into a care home.
Downsizing relief is there to protect the value of your assets passed on through your estate.
Shaun Moore, tax and financial planning expert at Quilter, said: “Selling a property to move into care doesn’t mean you lose your residence nil-rate band, so long as your estate still leaves assets of an equivalent value up to £175,000 to direct descendants.
“For instance, if the proceeds from selling your home are held as savings or investments that eventually pass to your children or grandchildren, your estate can claim the same level of inheritance tax relief as if you still owned the property.”
The key, he adds, is that the value must be inherited by lineal descendants, not friends, charities, or more distant relatives.
What to look out for with downsizing relief:
- The deceased must have lived in the property to qualify for RNRB.
- It’s not automatically applied to you. Some legal firms may ask you for this information, but not all. It’s up to you to claim the relief.
- Downsizing relief only applies when assets are left to lineal descendants; children, stepchildren, adopted children or grandchildren. If your will leaves property or proceeds to nieces, nephews, siblings, friends or a flexible trust, the allowance is lost.
- Residence nil rate band tapers once your estate exceeds £2 million.
What records should you keep?
Executors will need evidence of the property’s sale price and date, details of how the proceeds were used or invested, and valuations of the smaller property if one was purchased.
HMRC will also expect proof that the equivalent value was left to children or grandchildren so keeping a clear paper trail avoids unnecessary stress at an already difficult time.
Moore said: “People often underestimate how valuable the residence nil-rate band can be and how easy it is to accidentally lose it. If you’re considering downsizing or moving into care, it’s wise to speak to a financial planner or tax specialist before selling, so they can structure things in the most tax-efficient way and ensure the relief isn’t lost.”
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