Many people will consider downsizing as they get older, whether it’s when the kids leave home, when approaching or entering retirement, or at a later point when the day-to-day maintenance of a large house becomes impractical.
Those considering downsizing may be unsure of the tax implications of doing so.
Inheritance Tax
NRB & RNRB
Your main residence is within your estate for Inheritance Tax purposes, so there may be IHT for your estate to pay if your home and other assets combined are valued in excess of the Nil-Rate Band (NRB) when you die (£325,000 per person in 2020/21).
Since 2017, individuals who own their own home, and then upon death leave that home to at least one direct descendant (meaning their children, adopted children or step-children, and their subsequent line of descent) qualify for an extra tax-free allowance on death.
This is called the Residence Nil-Rate Band (RNRB) and stands at a maximum of £175,000 per person in 2020/21. The RNRB can only be used against the value of the home, so if your house is worth less than the RNRB then your estate won’t be entitled to the full amount.
It’s important to remember that the RNRB starts to reduce for estates valued above £2m, so if your estate is worth more than £2m then you won’t get the full RNRB.
The RNRB legislation makes provisions for downsizing if the downsized home is valued at less than the original home. This is to ensure that families aren’t disadvantaged from an IHT perspective as a result of the parent/grandparent downsizing.
The rules are complicated and the effect on you will depend on your personal situation. HMRC have detailed guidance on this issue (https://www.gov.uk/guidance/how-downsizing-selling-or-gifting-a-home-affects-the-additional-inheritance-tax-threshold) but it is quite technical and is likely to be confusing for many people. But it’s a good place to start.
If you’re unsure I would recommend seeking independent financial advice to understand how this would affect you.
Gifting money
There could be IHT advantages to downsizing if you were to give away some or all of the money that you release when you move to a cheaper property.
If you are above the IHT threshold before you downsize, giving some of that money away now will eventually move the funds out of your estate and potentially reduce the amount of IHT due on your death.
This may be particularly beneficial to those whose estate is over £2m currently, where giving away the intended gift amount would reduce the estate to below £2m afterwards, as this may mean you regain the full RNRB.
With any gift you must survive for 7 years after the date of the gift for the whole amount to be removed from your estate for IHT purposes. If you die within 7 years then your estate may need to pay some or all of the IHT that was due on the original gift amount, depending on when you died.
Again, the benefit to you and your estate will depend on your own situation and you should seek advice before making any gift.
Capital Gains Tax
Your main residence is exempt from CGT, so assuming the home you are selling has been your main residence continuously since you bought it, there will be no CGT to pay upon sale.
While there are no direct consequences to downsizing in respect of Capital Gains Tax, you may be affected by CGT in the long-term, depending on what you do with any equity that you release when you buy your downsized home.
If you were to use that released capital to invest in another asset (for example a second home, a rental property or an investment portfolio), then those assets will be liable to CGT upon their eventual sale.
Income Tax
In the same way as CGT, there are no direct consequences to downsizing in respect of Income Tax.
But again you may be affected in the long-term, depending on what you do with any equity that you release when you buy your downsized home.
If you were to use that released capital to invest in another asset then you may be liable to income tax on any income that was produced by the new asset.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. If investing, your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The Financial Conduct Authority does not regulate tax advice.
