The latest data from HM Revenue & Customs (HMRC) shows that the amount of Inheritance Tax (IHT) being paid by Britons continues to rise.

Figures reveal that, between April 2021 and March 2022, the government received £6.1 billion from IHT, an increase of £700 million when compared to the same period a year earlier.

While the figures might make for depressing reading, it’s worth remembering that the government provides several gifts and thresholds that you can use to reduce your estate’s exposure to IHT. As the tax is typically charged at 40%, using them could significantly increase the amount of money you leave to loved ones.

That said, the Telegraph reveals that bereaved families may be paying up to £140,000 in IHT unnecessarily, because of confusion over the little-known “downsizing addition” rule. The rule could allow you to retain an important threshold that’s linked to your home, even if you sell it.

Read on to discover more.

Your nil-rate band could allow you to leave £1 million to family IHT-free

The government allows you to have certain amounts of wealth when you die before your estate is liable to IHT. Known as the “nil-rate band”, the threshold means that you can typically have £325,000 as an individual, or £650,000 if you’re married (2022/23).

Additionally, you may also qualify for the residence nil-rate band (RNRB). It boosts your threshold on the condition that you leave your home to direct descendants, such as your children, grandchildren or adopted children.

If you’re eligible for RNRB, your threshold rises by £175,000 if you’re single or £350,000 if you’re married, meaning you may be able to leave up to £1 million to family IHT-free.

Remember, if your estate is exposed to IHT you could use gifting to reduce your wealth to within the thresholds, which could negate the tax. If you would like to learn more about gifting to reduce your liability, read our recent blog, which provides plenty of useful tips.

You could keep your RNRB even if you sell your home

As the additional threshold is based on the value of your home, you might assume it would be lost if you sold your property. In fact, HMRC may allow you to effectively retain all of your RNRB if you move into a less expensive property, or go into care.

This is thanks to the “downsizing addition”, which allows your beneficiaries to claim back the RNRB that was lost when you sold your home. Your beneficiaries can only apply for the addition after your death, and should claim it within two years of your passing.

That said, HMRC may extend the deadline in some instances.

If downsizing addition is granted, your estate’s total nil-rate band thresholds could be topped back up to £1 million, although strict conditions apply. These include:

• Your former home would have qualified for the residence nil-rate band if you’d stayed in it up until your death.
• You sold your property on or after 8 July 2015.
• All or some of your estate goes to direct descendants.

According to the Telegraph, because many beneficiaries do not know about the downsizing addition, or how to claim it, they may end up paying up to £140,000 in IHT unnecessarily. To demonstrate why, consider the following example that was featured in the article:

A widow sells her house in 2018 for £400,000 and moves into residential care, before dying in 2020. On her death, she leaves £650,000 in investments and £350,000 in cash to family.

As she has inherited her husband’s £325,000 NRB, she has a total NRB of £650,000, which means that the investments can be passed to the family IHT-free.

Yet, because the family wrongly assumes that the RNRB was lost when the widow sold her home, they pay HMRC £140,000 in IHT (40% of £350,000). If they had applied for downsizing addition, it’s likely they would not have paid anything.

Get in touch

As you can see, claiming the downsizing addition could be complex and a financial planner could help with the process of claiming it. If you would like to discuss it, or other ways to reduce your estate’s exposure to IHT, please contact us by calling 0800 434 6337. We’d be happy to help.

Please note:

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.