The IHT relief the taxman doesn’t want you to use

How to calculate the downsizing addition in five steps

Bereaved families face paying up to £140,000 in avoidable inheritance tax due to bewilderment over the death duty’s “most confusing” rule.

Since 2018 homeowners have benefited from extra tax breaks on their main home when passing it on to a direct descendant, known as the “main residence nil-rate band”, or “family home allowance”.

Today this stands at £ 175,000 and comes on top of the standard £325,000 allowance. Spouses and civil partners can share their allowances.

People who sell an expensive property to downsize or to go into care can claim a tax credit known as the “downsizing addition” so they still qualify for the enhanced protections.

But many are unaware they qualify. The Government’s own tax adviser, the Office of Tax Simplification, said in a report that downsizing rules were the most complicated aspect of the 40pc death tax and that virtually no one was able to work them out without the help of professionals.

Now, with more people downsizing, living longer and moving into care in later life, an increasing number risk missing out.

Almost two million people said they planned to downsize last year after the stamp duty holiday removed one of the greatest barriers to moving, according to property builders Audley Villages.

It comes as thousands more are expected to pay the death toll this year due to high pandemic death rates and booming house prices.

Sean McCann of advisers NFU Mutual said the rules were “horrendously complex”.

“They are meant to stop people from rattling around big houses to make the most of tax breaks on their homes, but it is the families who have to claim the addition and most lay executors have no idea it exists at all,” he said.

“More people are downsizing because of the stamp duty holiday and our ageing population means more and more are selling their homes and moving into care.

“What’s more, the rules apply to anyone who has sold their home or downsized to a smaller property since July 2015. It means the window on claims is growing and more people will be caught out over time, needlessly losing thousands to the taxman.”

Missing out can cost families six-fig

Family home allowance

Work out the amount of family home allowance you would have been eligible for before selling your home

Find the percentage

Divide the value of the home when sold by the family home allowance amount calculated above. Multiply this figure by 100 to get a percentage

Repeat

Divide the value of the current downsized home by the family home allowance and multiply by 100 again. If you are in care, multiply the number by zero

Find the gap

Deduct the percentage you calculated in step two from the percentage you came up with in step three

Multiply for the result

Multiply the figure calculated in step four by the family home allowance at the time of death (£175,000 today). This gives you the amount of lost family home allowance and the addition you can claim ure sums. As an example, consider a widow who sold her house in 2018 for £400,000 and moved into residential care, but later died in 2020, leaving £ 650,000 in investments and £350,000 in cash to her family.

Her relatives use her and her late husband’s main IHT allowance so the investment portfolio passes tax free. They wrongly believe they cannot claim the family home allowance, as the house was sold previously, and are hit with a £140,000 death tax bill.

But by claiming the downsizing addition they could have cut the tax bill entirely.

It is calculated using a five-step process (see middle) and will depend on the value of the house when sold or downsized, the date of death and the value passing to direct descendants.

It will normally be the same as the family home allowance that has been lost because of a sale.

The addition will also depend on the value of the other assets left to family members. It must be claimed by the executors of the estate when they complete the IHT paperwork.

Families have two years to claim the allowance after death, although HM Revenue & Customs said it might consider later claims in some circumstances.

Mooted policies to get around the confusion include scrapping the family home allowance altogether and instead boosting the main IHT allowance to £500,000 per individual, which would apply regardless of whether you own a home or not.

The OTS calculated this would result in 34,000 fewer people paying the death duty by 2023-24, but would cost the Government £7.5bn.

Another option to get around this shock to state income would be to gradually increase the £ 325,000 allowance with inflation and phase out the family home allowance at the same time.

The main IHT allowance has not increased since 2009. The Chancellor, Rishi Sunak, announced in the Budget in March that the threshold would stay frozen for at least another five years.

The OTS has said the rules “will continue to confuse and cause problems unless a more straightforward way to achieve broadly the same policy outcome is achieved”.