Downsizing and Inheritance Tax: What Happens?

The residence nil rate band only applies to a property that is (or was, under the downsizing rules) the deceased's home, passing to children, grandchildren or other direct descendants. Without special provision, someone who sold their family home to downsize, or moved into a care home and gave up owning any property, would appear to lose the allowance entirely, even though the reason for the change was often nothing to do with tax planning.

The downsizing addition rules exist specifically to prevent this outcome, allowing the estate to claim an amount reflecting the lost residence nil rate band, provided certain conditions are met.

Broadly, if you sold, gave away, or downsized from a qualifying home on or after 8 July 2015, and other assets of at least equivalent value pass to direct descendants on your death, your estate can claim a downsizing addition. This addition is calculated based on what the residence nil rate band would have been worth had you kept the more valuable property, less what is actually available because you no longer own it.

The calculation considers the value of the previous home, the date of the downsizing move, the residence nil rate band rate in force at your death, and the value of assets actually passing to direct descendants. Because several of these figures can change over time (the residence nil rate band itself was introduced gradually from 2017), the calculation for someone who downsized years before death can be more complex than it first appears.

Importantly, the assets that eventually pass to direct descendants to trigger the downsizing addition do not have to be the smaller replacement home. They can be any assets in your estate, cash, investments, personal possessions, provided their value is sufficient and they pass to qualifying descendants.

This means someone who downsized and then spent some of the proceeds, but left other assets of adequate value to children, can still potentially benefit from the addition. Working out exactly how much is available, however, needs a careful calculation rather than assumption.

The residence nil rate band, including any downsizing addition, tapers away for estates worth more than £2 million, reducing by £1 for every £2 the estate exceeds that threshold. For very large estates, this can reduce the available allowance to nothing regardless of downsizing.

This interacts with the downsizing calculation in a way that makes larger or more complex estates particularly worth getting checked professionally, since the taper is applied to the notional amount as well as any actual residence nil rate band claimed.

If you have already sold or given up a larger home, keep records of the sale, its value, and the date, along with your intentions for who ultimately inherits your remaining assets. Make sure your will clearly leaves sufficient value to direct descendants if you want the downsizing addition to be available; leaving everything to a spouse only, for example, defers the question to the second death.

If you are considering downsizing and are concerned about the inheritance tax effect, a solicitor or tax adviser can model the downsizing addition calculation for your specific figures before you act, rather than leaving your executors to work it out (and possibly lose part of the relief) after your death.