When you inherit a property in the UK, capital gains tax (CGT) may be payable if you decide to sell the property and it has increased in value since the time it was inherited. However, CGT does not apply at the moment of inheritance. It only becomes a factor when the property is sold at a profit. Understanding the rules, rates, and potential tax reliefs is crucial for managing your tax liability when dealing with inherited property.
This guide will walk you through how capital gains tax on inherited property works, how to calculate it, and ways to reduce your tax liability.
Capital Gains Tax (CGT) is a tax on the profit made when you sell or dispose of an asset that has increased in value. It applies to various assets, including property, shares, and investments. The tax is based on the gain made, not the total sale price. For property, CGT is calculated on the difference between the market value at the time of inheritance and the sale price.
CGT does not apply at the time you inherit a property, but it may be due when you sell the property later, and only if the property has increased in value.
Here are key scenarios where CGT may apply to inherited property:
Selling the Inherited Property:
If you sell the inherited property for more than its value at the time of inheritance, CGT is payable on the profit (the gain). The gain is calculated based on the market value of the property on the date of inheritance, not the original purchase price paid by the deceased.
Using the Property as a Second Home or Rental:
If you decide to rent out the property or use it as a second home, CGT will apply when you eventually sell it. This is because it is not your main residence, and therefore, you do not qualify for private residence relief.
Selling the Property Below Inheritance Value:
If you sell the property for less than its value at the time of inheritance (i.e., there is no gain), no CGT is payable. However, if there are any gains made (i.e., if the sale price exceeds the inherited value), CGT may be payable on the profit.
To calculate the CGT you owe, you need to determine the gain (profit) made on the property sale and apply the relevant tax rate. Here’s how to calculate CGT on inherited property:
Determine the Market Value at the Time of Inheritance:
The starting point for calculating CGT is the market value of the property at the date of inheritance. This value is often established during the probate process and forms the basis for any future CGT calculations.
Subtract Allowable Costs:
You can deduct certain costs from the gain to reduce your CGT liability, including:
Subtract the Annual CGT Allowance:
In the UK, individuals have an annual tax-free CGT allowance, known as the Annual Exempt Amount. For the 2023/2024 tax year, this is £6,000 per individual. This means that the first £6,000 of any gain is tax-free.
Apply the Capital Gains Tax Rate:
CGT rates for property are higher than for other assets. The rates depend on your income tax band:
The tax rate is applied to the taxable gain (the gain minus the allowable deductions and CGT allowance).
You inherit a property worth £300,000. Five years later, you sell it for £400,000. During the sale, you incur £10,000 in estate agent and legal fees, and you’ve spent £15,000 on home improvements. Here’s how you calculate CGT:
There are several ways to reduce your CGT liability when selling inherited property:
Private Residence Relief (PRR):
If you make the inherited property your main residence and live in it for a period of time, you may qualify for Private Residence Relief, which can significantly reduce or eliminate your CGT liability when you sell the property.
Annual CGT Allowance:
Ensure you make use of your Annual Exempt Amount each tax year to reduce the amount of gain subject to CGT. If the property is co-owned (e.g., inherited by multiple beneficiaries), each person can apply their CGT allowance.
Transfer to Spouse or Civil Partner:
If you are married or in a civil partnership, you can transfer ownership of part of the property to your spouse without triggering CGT. This allows you both to use your annual CGT allowances, potentially doubling the tax-free amount.
Home Improvements:
Keep detailed records of any significant home improvements or renovations you make to the inherited property. These costs can be deducted from your CGT liability, reducing the taxable gain.
Timing the Sale:
If your income fluctuates, consider selling the property in a year where your income is lower, as this could place you in a lower tax band, reducing the rate of CGT from 28% to 18%.
It’s important to distinguish between Inheritance Tax (IHT) and Capital Gains Tax (CGT), as they apply in different situations:
Inheritance Tax (IHT): This is a tax on the estate of the deceased, including property, cash, and other assets. IHT is payable if the value of the estate exceeds the nil-rate band of £325,000 (or up to £500,000 if the property is passed to direct descendants). The executor of the estate is responsible for paying IHT.
Capital Gains Tax (CGT): This applies when you sell the inherited property and make a profit on its sale. You do not pay CGT on the property at the point of inheritance, but only when you sell it, assuming there has been an increase in value.
At Fraser Bond, we understand the complexities of managing inherited property and the tax implications that come with it. We can assist with:
Property Valuations: Helping you determine the accurate market value of the property at the time of inheritance for tax purposes.
Tax Advice: Offering expert guidance on reducing your CGT liability when selling inherited property.
Property Sales: Assisting with selling inherited properties, managing the legal and financial aspects to make the process smoother.
If you inherit property in the UK and later sell it, you may be subject to capital gains tax if the property has increased in value since the inheritance. Understanding how to calculate CGT and the available deductions can help you manage your tax liability effectively. For professional advice on dealing with inherited property and tax issues, contact Fraser Bond.
