The residence nil rate band (RNRB) was introduced in April 2017 to allow individuals to pass on a greater proportion of their estate free from inheritance tax (IHT) if they leave their home to direct descendants. However, the rules around the RNRB can cause issues for those living in retirement communities, as the estate of a deceased individual may not qualify due to the requirements to sell the property back to the management company on death.
Losing the RNRB on Retirement Homes
The RNRB provides an additional nil rate band of up to £175,000 when a person dies if they leave a residence to direct descendants. This means married couples and civil partners can pass up to £1 million free of IHT. To qualify, the deceased must have owned a property that was their residence at their time of death, and the property must pass to a direct descendant, such as a child or grandchild.
The problem arises for those living in retirement communities when the contract requires the property to be sold back to the management company upon the resident’s death. The property does not pass to the direct descendants in these cases, so it fails to meet the RNRB conditions. This could result in the loss of the £175,000 RNRB for these individuals.
For example, if a widow living in a retirement flat worth £300,000 dies with an estate of £850,000, the current IHT nil rate band of £325,000 would cover the flat, leaving £525,000 potentially liable to IHT. If she could use the RNRB, the first £500,000 would be tax-free, but as the flat goes back to the management company, her estate can only use the standard nil rate band of £325,000. This leaves £525,000 over the threshold, resulting in an IHT bill of £210,000 that could have been avoided.
Exploring Potential Solutions
Some individuals in this situation have tried to find ways around the RNRB conditions to avoid losing the tax break. One option is to remove the requirement to sell the property back to the management company from the contract. However, this requires agreement from the company, who may be reluctant to allow this.
Another potential solution is for the owner to specify in their will that the property should be sold after death by the executors and the proceeds passed to direct descendants. This meets the intention of the RNRB rules, even though the beneficiaries do not inherit the physical property. However, the management company may still refuse to allow the removal of the sale condition from the contract.
Confirming the Rules Allow Sale By Executors
Fortunately, HMRC has confirmed that a direct descendant does not need to take ownership of the property to qualify for RNRB. The tax break can still apply if the will states the property is intended for direct descendants, even if the executors must sell the home and pass on the proceeds.
If the will directs the sale of the property and distribution of sales proceeds to descendants after death rather than the automatic sale back to the management company, then the estate can still benefit from RNRB. This provides a solution for those in retirement properties, as altering the will is more feasible than changing the property contract.
Professional advice should still be sought to ensure the will is drafted appropriately and the sale proceeds are inherited directly by descendants outside the estate administration process. Careful planning can minimise the IHT impact and ensure retirement community residents retain their full RNRB allowance.
Reviewing the Downsizing Addition
If the below conditions are not met, the estate may still qualify for the downsizing addition, providing a similar IHT exemption. This applies where downsizing means the deceased’s home no longer qualifies for RNRB at the time of death. The downsizing addition provides an extra nil rate band of up to £175,000 based on the value of the original home.
To claim the downsizing addition, the deceased must have sold a home they lived in and then left assets of an equivalent value to direct descendants in their estate. This provides an alternative exemption for those whose home sale proceeds go to descendants, even if they no longer own a qualifying residence.
If you live in a retirement home, call our tax advisors for professional advice to review whether the downsizing addition could apply and ensure estates legitimately reduce their IHT liability.
The RNRB rules were intended to help more people pass assets IHT-free to direct descendants, but they can disadvantage owners of retirement properties required to sell their homes to the management company. With HMRC confirming that the sale of the home by executors can qualify and the downsizing addition as a potential fallback, solutions are available to ensure these estates keep the tax break. However, proactive estate planning and expert advice are required to ensure it will meet the technical requirements.