What is Capital Gains Tax?
Before we look at Capital Gains Tax on inherited property, we need to explain Capital Gains Tax. Capital Gains Tax (CGT) is a tax imposed on the profit you make when you sell or dispose of an asset that’s risen in value from the date you acquired it. It is the increase in value that’s taxed rather than the amount you receive.
Whether you sell an asset or gift it to someone, exchange it for something else or receive compensation for it such as in the form of an insurance pay-out, the profit made (which is the gain) may be liable to CGT.
CGT applies to most personal possessions worth more than £6,000, excluding your car, unless you use the car as part of your business. Other types of personal possessions such as anything with a limited lifespan are also excluded unless used for business use.
Property wise, CGT applies if it isn’t your main home such as land, buy-to-let or inherited property, or if part of your main home has been rented out (although an exemption may apply) or used for business purposes.
CGT also applies to shares and certain business assets.
However, CGT does not apply to Individual Savings Accounts (ISAs) and Personal Equity Plans (PEPs).
What is Inheritance Tax?
Sometimes capital gains tax is confused with probate and Inheritance Tax (IHT). To clarify IHT is a tax on the estate of someone who has died and is normally paid by the deceased person’s estate.
You don’t pay IHT if the value of the estate is below the inheritance tax threshold. Any value of the estate above the relevant threshold is taxed at the rate of 40% which is the IHT rate.
How does Capital Gains Tax apply to inherited property?
CGT applies to inherited property either when the property is sold by the estate or when it comes to selling the property at a later date if it was transferred to a beneficiary. CGT is payable on the inherited property on the gain made if the probate property has risen in value since the person died (not when the person who has passed away acquired it).
Who pays CGT on inherited property?
If the property is sold by the estate, the estate is liable to pay any CGT on the property. However, if the property is transferred to a beneficiary who inherits the property, when the beneficiary decides to sell their inherited property or to give it away, they must pay CGT on the increase in value.
How much Capital Gains Tax is payable?
The amount of CGT you pay on selling probate property depends on your Income Tax rate and the size of the gain. For basic rate taxpayers, the CGT rate is 18% and for higher tax rate payers it is 28%, for residential properties.
However, it is not always easy to work out the size of the gain and which rate applies to you when you’re selling probate property.
As a guide, you need to establish the value of the inherited property when it’s sold and then takeaway its value when you inherited it plus any costs spent on the property, to achieve your total gain.
You then pay CGT if your total taxable gain is more than your yearly CGT allowance.
By taking away your tax-free allowance from your total taxable gains and then adding this to your overall taxable income, you will establish if this total falls within the basic band for income tax. If it does, you’ll pay 18% on your gains. This increases to 28% for amounts over the basic rate. These rates apply to gains on residential property. Different rates may apply to other types of assets subject to a gain.
Calculating your CGT liability can be a complicated exercise. If you have questions we offer a free twenty minute consultation with a probate solicitor.
Ways to minimise Capital Gains Tax on inherited Property
The good news is there are some legitimate ways to reduce your CGT when it comes to selling probate property.
Transferring ownership
If you sell or gift the inherited property straightaway, before it can increase in value, you can minimise the amount of CGT there is to pay. There is also no CGT to pay on inherited property you give or sell to your spouse or civil partner, even if there had been an increase in the value of the property between the time of inheriting and selling the probate property, although your spouse or civil partner would likely need to pay CGT if they sell the property at a later date.
Exemptions and reliefs
If you’re married or in a civil partnership, you can transfer inherited property into joint names which would enable you to combine both tax-free allowances (providing a double allowance) which will help offset any CGT owed at the time of selling.
Principal Private Residence Relief
The rule of the Principal Private Residence Relief states you are not liable to pay CGT on a property that is your main home – so by making your inherited property your main residence, you can claim relief on it when you sell. You should have lived in the property for the entire time you owned it, although there are exceptions to this requirement, and you can still reduce the taxable amount if you lived in the property for only some of the time.
Entrepreneur’s Relief
Also known as Business Asset Disposal Rate Relief, Entrepreneur’s Relief applies if you’ve used your inherited property for business purposes. The rule states you pay CGT at the reduced rate of 10% regardless of the income tax band you’re in. You can use Entrepreneur’s Relief as many times as you like up a value of £1million in tax relief.
Taking advantage of allowable expenses
When calculating the amount of CGT on inherited property, it’s sensible to make the most of certain expenses that can be discounted from your total gains amount. Allowable expenses include any legal or estate agency fees incurred during the sale of probate property as well as any money spent on renovating or extending the property prior to selling it.
Exemptions and reliefs
You can use your CGT allowance to reduce the amount of tax you pay on selling your inherited property. Make the most of your basic income tax rate band if this applies to you as any gains can fall within the threshold of this rate, enhanced further by making pension contributions or Gift Aid donations.
Another exemption is gifting the inherited property to charity; and hold-over relief would enable you to defer your capital gains tax bill until the new owner of the inherited property sells the property at a later date. Hold-over relief is also applicable on assets transferred into a trust.
Speak to a specialist probate solicitor to find out how you could reduce your capital gains tax bill on inherited property through making the most of exemptions and reliefs, to keep the total you pay to a minimum.
In summary: Calculating Capital Gains Tax on inherited property
To work out how much capital gains tax you owe when you sell your inherited property, you need to establish the value of your profit – that is, how much you have gained in terms of the value increase from the date you inherited and the date you sold the property. You then need to calculate any costs incurred and your level of allowance plus any exemptions or reliefs that apply to your situation, to establish the amount of tax owed.
It’s worth remembering that you won’t receive a bill for CGT. You must work out what your total gains are above your tax-free allowance, and then report it to HMRC and pay the capital gains tax within a strict timeframe.
