Downsizing Relief: how it can cut your Inheritance Tax bill

Have you heard of ‘downsizing relief’ or the ‘downsizing addition’? If not, the good news is that it is something that can save you thousands in Inheritance Tax. The bad news is that it is a fiendishly complex component of Inheritance Tax. In a 2019 report, the Office of Tax Simplification said that it was so complicated that people usually needed professional help to work it out.

In this blog post, we’ll take a look at what the downsizing relief is and how it works. We won’t delve too deeply into the complex calculations you need to make. Instead, we’ll help you work out whether you qualify for the relief and whether it’s likely to save you money.

What is downsizing relief?

To qualify for the downsizing addition, you need to meet these three conditions:

• A person must have sold, gifted or downsized to a less valuable home on or after 8th July 2015
• The home would have qualified for the Residence Nil Rate Band (RNRB) if the person had kept it until their death
• Direct descendants must inherit at least some of the estate.

The downsizing addition is normally the same as the RNRB lost when the former home was removed from the estate.

The maximum RNRB for 2020 to 2026 is £175,000. A personal representative of the estate has to claim the downsizing addition within two years from the end of the month in which a person died. However, HMRC will sometimes accept later applications. Only one home can be taken into account. If a person downsized two or more times, or they sold or gave away more than one home, you can choose which property to use for calculating RNRB.

Why the downsizing relief is complex

The relief is complex because calculating depends on so many different variables. For example, the maximum available RNRB between 8th July 2015 and 6th April 2017 was £100,000. For the tax year 2018 to 2019 it was £125,000. These ceilings can affect your calculations, depending on when a home was sold.

To give you an idea of how complex calculating RNRB can be, we’ve summarised this example from the HMRC website.

Example calculation

A widow sells her home in June 2018. It was worth £195,000. The maximum RNRB for that tax year was £125,000.

The widow dies in August 2020. There is no longer a home in her estate. The maximum RNRB for the 2020/21 tax year is £175,000.

The widow’s estate benefits from the transferred RNRB of £175,000 from her late husband’s estate.

Based on this information, this is how to calculate the lost RNRB.

1. The maximum RNRB when the property was sold was £125,000. The estate also benefits from the transferred RNRC of £175,000. Therefore, the maximum RNRB available at the time of the sale was £300,000.
2. The house was worth £195,000 when sold. You divide this figure by the £300,000 to get a percentage of 65%.
3. There’s no home in the estate so the percentage is 0%.
4. Taking 0% from 65% gives a percentage of 65%.
5. When the widow dies, the maximum RNRB is £175,000. The estate is entitled to the transferred RNRB of £175,000. The maximum RNRB for the estate is thus £350,000. The ‘lost’ RNRB is 65% of £300,000 – i.e. £227,500.

This is when things get even more complex. The amount of RNRB available to the estate now depends on the value of any other assets the widow leaves to her direct descendants.

If the widow had downsized to a smaller property, there would have been a percentage in step 3. Assuming this were smaller than the percentage in step 2, the estate would qualify for the downsizing addition. If it were the same or higher, there’d be no downsizing addition.

How to get your calculations correct

We’ve barely scratched the surface of calculating the downsizing addition. If you want to delve deeper, the HMRC website has a very long and complex page on the subject.

The key point is that, if a property has been sold before a person dies, it can still provide you with a tax break for Inheritance Tax purposes. If you’d like us to accurately calculate downsizing relief for your estate, please get in touch. We’d be delighted to help.