Capital Gains Tax on Inherited Property

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Inheriting property can be both a blessing and a financial puzzle. One of the most common questions that arise is, "Do I have to pay capital gains tax on inherited property?" The short answer is: it depends.

Capital gains tax on inherited property is more complex than you might think. While you don't typically owe tax just for inheriting, you might face tax implications if you later sell the property for more than its value when you inherited it.

This blog aims to demystify the complex world of capital gains tax on inherited property. We'll explore when you might need to pay, how it's calculated, and what exemptions or reliefs might apply. Understanding the tax implications is crucial if you plan to keep, sell, or rent out an inherited property.

By the end of this guide, you'll have a clearer picture of your potential tax obligations and how to navigate them effectively.

What is capital gains tax on inherited property?

Capital gains tax on inherited property is a tax you might have to pay when you sell a property you've inherited. But what exactly is it? Simply put, it's a tax on the profit you make from selling the inherited property.

Here's how it works: When you inherit a property, its value at the time of the previous owner's death becomes your starting point. This is called the 'probate value'. If you later sell the property for more than this value, the difference is your 'capital gain'. The tax is calculated on how much the increase is since the person's death.

For example, if you inherited a house valued at £200,000 and sold it years later for £250,000, your capital gain would be £50,000. You'd potentially pay tax on this £50,000, not on the full £250,000 sale price.

Do you have to pay capital gains tax when you inherit a property?

The short answer is no, you don't have to pay capital gains tax at the moment you inherit a property. However, it's important to understand that you might have to pay capital gains tax in the future if you decide to sell the inherited property.

Here's what you need to know:

  • Inheritance itself isn't taxed: When you inherit a property, you don't immediately owe any capital gains tax. The inheritance process is separate from capital gains considerations.

  • Tax becomes relevant upon sale: Capital gains tax only comes into play if and when you sell the inherited property.

  • The tax is on the gain: If you do sell, you'll only be taxed on the increase in value from the time you inherited the property to when you sell it.

  • Valuation is key: The property's value at the time of inheritance becomes your 'base cost'. This is crucial for calculating any future capital gains.

  • Time matters: If you use the inherited property as your main home immediately after inheriting it, you might qualify for tax relief when you sell.

  • Other taxes to consider: While you don't pay capital gains tax upon inheritance, be aware that inheritance tax might apply to the estate of the person who left you the property.

Tax laws can be complex and change over time. It's always a good idea to consult with a tax professional or financial advisor for personalised advice, especially when dealing with significant assets like inherited property. They can help you understand your specific situation and potential tax obligations.

How is capital gains tax calculated on inherited property?

Calculating capital gains tax on inherited property might seem daunting, but it's quite straightforward once you understand the basics. Let's understand it step by step:

  1. Determine the property's value at the time of inheritance:
    When you inherit a property, its value at that time becomes your "base cost" or "acquisition value." This is typically the market value of the property on the date of death of the person who left it to you. This value is crucial because it's the starting point for calculating any future capital gains.

  2. Calculate the gain when you sell:
    If you decide to sell the inherited property, you'll need to calculate the difference between the sale price and the base cost. This difference is your capital gain (or loss if the property has decreased in value).

    Base cost (value when inherited): £200,000

    Sale price: £250,000

    Capital gain: £50,000 (£250,000 - £200,000)

  3. Consider allowable deductions:
    You can deduct certain costs from your gain, such as:

    1. Costs of improvements to the property (not regular maintenance)

    2. Legal fees and estate agent fees for selling the property

    3. Stamp duty paid when inheriting the property (if applicable)

    Let's say you spent £10,000 on home improvements. Your taxable gain would now be £40,000 (£50,000 - £10,000).

  4. Apply for your tax-free allowance:
    In the UK, everyone has an annual Capital Gains Tax allowance (£12,300 for the 2023/24 tax year). You only pay tax on gains above this amount.

    Continuing our example:

    Taxable gain: £40,000

    Tax-free allowance: £12,300

    Gain subject to tax: £27,700 (£40,000 - £12,300)

  5. Calculate the tax owed
    The rate of Capital Gains Tax you pay depends on your income tax band and the type of asset. For residential property, basic rate taxpayers pay 18%, while higher and additional rate taxpayers pay 28%.

    If you're a higher rate taxpayer:

    Tax owed: £7,756 (£27,700 x 28%)

This is a simplified explanation. The actual calculation can be more complex depending on various factors, such as whether you've used the property as your main residence or if you're selling only a portion of the inherited property.

It's always wise to consult with a tax professional or use HMRC's resources for the most accurate calculation based on your specific circumstances. They can help ensure you're claiming all eligible reliefs and paying the correct amount of tax.

When do you pay capital gains tax on inherited property?

A common question many people ask is, "When do I actually have to pay capital gains tax on inherited property?" The answer is straightforward: you don't pay capital gains tax simply by inheriting a property. Instead, you only pay when you sell or dispose of the inherited property.

Here's a simple breakdown of when capital gains tax comes into play:

  1. At the time of inheritance: No tax is due when you inherit the property. The inheritance itself doesn't trigger capital gains tax.

  2. While you own the property: As long as you keep the inherited property, you won't owe any capital gains tax, even if its value increases.

  3. When you sell the property: This is when capital gains tax becomes relevant. If you sell the inherited property for more than its value at the time you inherited it, you may need to pay capital gains tax on the profit.

  4. It's important to note that the taxable gain is calculated based on the difference between the property's value when you inherited it (known as the 'probate value') and the amount you sell it for. For example:

    1. Probate value when inherited: £200,000

    2. Selling price: £250,000

    3. Potential taxable gain: £50,000 (minus any allowable expenses)

You have an annual tax-free allowance for capital gains (£12,300 for the 2023/24 tax year). If your gain falls within this allowance, you won't owe any tax.

Also, if you've used the property as your main residence for the entire time you've owned it, you may be exempt from capital gains tax under the Private Residence Relief rules.

Understanding when capital gains tax applies to inherited property can help you make informed decisions about what to do with the property and when to sell it if that's your intention.

Exemptions and reliefs for capital gains tax on inherited property

Capital gains tax on inherited property can be a significant financial burden, but there are several exemptions and reliefs available that can help reduce or eliminate this tax. Here are the key points to understand:

  1. Principal private residence relief: If you move into the inherited property and use it as your main home, you may be exempt from capital gains tax when you sell it.

  2. Spouse or civil partner exemption: If you inherit property from your spouse or civil partner, there's typically no capital gains tax to pay when you inherit or sell the property.

  3. Annual tax-free allowance: Everyone has an annual capital gains tax allowance (£12,300 for the 2023/24 tax year). You only pay tax on gains above this amount.

  4. Holdover relief: This allows you to pass on the property to someone else (usually a family member) without paying capital gains tax at that time.

  5. Lettings relief: If you've lived in the property at some point and also let it out, you may be eligible for some tax relief.

  6. Inheritance tax paid: If inheritance tax was paid on the property when you inherited it, this can be deducted from any capital gains tax due when you sell.

  7. Improvements to the Property: The cost of any improvements you've made to the property can be deducted from your gain, potentially reducing your tax bill.

Understanding these exemptions and reliefs can help you manage your tax liability more effectively when dealing with inherited property.

Capital gains tax on jointly owned inherited property

Capital gains tax on jointly owned inherited property can be a bit more complex, but understanding it is crucial for those who find themselves in this situation. The key question here is: "How does capital gains tax work when multiple people inherit a property together?"

When a property is inherited jointly, each owner is responsible for their share of any capital gains tax that may arise when the property is sold. Here's how it typically works:

  1. Ownership share: The capital gains tax liability is usually split according to each person's ownership share. For example, if three siblings inherit a property equally, each would be responsible for one-third of any capital gains tax due.

  2. Individual allowances: Each owner can use their own annual capital gains tax allowance (also known as the Annual Exempt Amount) against their share of the gain. This means that in some cases, the total tax bill might be lower than if a single person owned the property..

  3. Different intentions: Joint owners might have different plans for the property. One might want to sell while another wants to keep it. In this case, those who sell their share will need to consider capital gains tax on their portion.

  4. Buyouts: If one owner buys out the others, this is treated as a disposal for capital gains tax purposes for those selling their share.

  5. Record keeping: All joint owners need to keep clear records of any improvements or expenses related to the property, as these can be used to reduce the taxable gain.

  6. Professional advice: Given the complexity of joint ownership situations, it's often wise to seek professional tax advice to ensure all owners understand their liabilities and options.

Joint ownership can complicate matters, it can also provide opportunities for tax planning if handled correctly.

Selling an inherited property: tax considerations

Selling an inherited property can trigger capital gains tax, but understanding the process can help you navigate this financial challenge. The key question is: How does selling an inherited property affect your tax situation?

When you sell an inherited property, you're only taxed on the capital gains that occurred since you inherited it. This is because the property's value is "stepped up" to its fair market value at the time of the previous owner's death. For example, if you inherit a house worth £200,000 and later sell it for £250,000, you'd only pay capital gains tax on the £50,000 increase.

However, several factors can influence your tax liability:

  1. How long you've owned the property: If you've used it as your main residence for all or part of the time, you might qualify for private residence relief.

  2. Improvements made: The cost of any improvements you've made can be deducted from the gain.

  3. Selling expenses: Costs like estate agent fees and legal fees can be deducted from the gain.

  4. Your tax status: The rate of capital gains tax you pay depends on your income tax band.

You have an annual capital gains tax allowance (£12,300 for the 2023/24 tax year), which can help reduce your tax bill. It's always wise to consult with a tax professional to understand your specific situation and potential tax obligations when selling an inherited property.

Renting out an inherited property: tax implications

Renting out an inherited property can be a smart way to generate income, but it's essential to understand the tax implications. Here are the key points to consider:

  1. Income tax: Any rental income you receive will be subject to income tax. You'll need to report this on your tax return.

  2. Allowable expenses: You can deduct certain expenses from your rental income, such as property maintenance, insurance, and mortgage interest.

  3. Capital gains tax: If you later sell the property, you may still be liable for capital gains tax on any increase in value since you inherited it.

  4. Furnished holiday lets: If the property qualifies as a furnished holiday let, it may be eligible for certain tax advantages.

  5. Inheritance tax: Renting out the property doesn't affect any inheritance tax that may have been due when you inherited it.

  6. Property income allowance: You can earn up to £1,000 in rental income tax-free under the Property Income Allowance.

  7. National insurance: If your rental activities constitute a business, you may need to pay Class 2 National Insurance contributions.

  8. Record keeping: It's crucial to keep accurate records of all income and expenses related to the property.

By understanding these points, you can make informed decisions about renting out your inherited property and ensure you're complying with all relevant tax obligations.

How to minimise capital gains tax on inherited property?

How can you minimise capital gains tax on inherited property? Here are several strategies to help reduce your tax burden:

  1. Live in the property: If you make the inherited property your main residence for at least two years, you may qualify for the Principal Private Residence Relief. This could exempt you from paying capital gains tax on the property when you sell it.

  2. Sell quickly: If you sell the property soon after inheriting it, there might be little to no capital gain, resulting in minimal or no tax owed.

  3. Offset gains with losses: If you've made losses on other investments in the same tax year, you can use these to offset your capital gains, potentially reducing your tax bill.

  4. Use your annual exemption: Each person has an annual capital gains tax allowance. By timing your sale carefully, you could spread the gain over two tax years, using two years' worth of allowances.

  5. Improve the property: Keep records of any improvements you make to the property. These costs can be deducted from the gain when you sell, potentially lowering your tax bill.

  6. Gift the property: If you gift the property to a spouse or civil partner, there's usually no capital gains tax to pay. However, be aware that other tax implications may apply.

  7. Consider partial ownership: If you inherit the property with others, you might be able to transfer your share to them, potentially staying within your tax-free allowance.

By employing these strategies, you can potentially reduce the amount of capital gains tax you'll need to pay on an inherited property. Always consider your circumstances and consult with a tax expert to determine the best approach for your situation.

Difference between inheritance tax and capital gains tax

When dealing with inherited property, it's important to understand the difference between Inheritance Tax and Capital Gains Tax. These are two distinct types of taxes that can apply in different situations, and knowing the difference can help you better manage your financial obligations.

What is Inheritance tax?

Inheritance Tax is a tax on the estate (property, money, and possessions) of someone who has died. It's paid on the value of the deceased person's estate above a certain threshold, which is currently £325,000 in the UK (as of 2024). Here are some key points about Inheritance Tax:

  1. It's usually paid by the executor of the will or the administrator of the estate using funds from the estate.

  2. The current Inheritance Tax rate is 40% on anything above the threshold.

  3. There are various exemptions and reliefs available, such as transfers between spouses or to charities.

  4. Inheritance Tax is paid before the beneficiaries receive their inheritance.

What is Capital gains tax?

Capital Gains Tax, on the other hand, is a tax on the profit when you sell (or 'dispose of') something that has increased in value. For inherited property, it applies when you sell the property. Here's what you need to know:

  1. It's calculated based on the increase in value from when you inherited the property to when you sell it.

  2. The person who inherits the property doesn't pay this tax immediately upon inheritance.

  3. The rate of Capital Gains Tax varies depending on your income tax band and the type of asset.

Key Differences

  1. Timing: Inheritance tax is paid shortly after a person dies, while capital gains tax is only paid when you sell the inherited asset.

  2. Who pays: Inheritance tax is typically paid by the estate before assets are distributed. Capital gains tax is paid by the beneficiary who sells the inherited asset.

  3. What it's based on: Inheritance tax is based on the total value of the estate at the time of death. Capital gains tax is based on the increase in value of a specific asset from the time of inheritance to the time of sale.

  4. Thresholds: Inheritance tax has a set threshold (£325,000 as of 2024) below which no tax is due. Capital gains tax has an annual exempt amount (£6,000 for 2023/24), but this applies to all capital gains, not just those from inherited property.

  5. Rates: Inheritance tax is a flat rate of 40% above the threshold. Capital gains tax rates vary depending on your income tax band and the type of asset.

By understanding these differences, you will be better equipped to handle the financial aspects of inheriting property and make informed decisions about what to do with your inheritance.

Deadlines of paying capital gains tax on inherited property

When it comes to paying Capital Gains Tax (CGT) on inherited property, timing is crucial. Here are the key deadlines you need to know:

  1. Reporting the sale: If you sell the inherited property after 6 April 2020, you must report and pay any CGT due within 60 days of the completion of the sale

  2. UK property tax return: This must be submitted online within 60 days of the property sale completion.

  3. Self assessment tax return: If you're registered for Self-Assessment, you should also report the sale on your annual tax return by 31 January following the tax year of the sale.

  4. Payment deadline: CGT is due within 60 days of the completion of the sale.

  5. Late payment penalties:

    1. Interest starts accruing from day 61 if the tax isn't paid.

    2. A 5% late payment penalty may be charged if the tax remains unpaid after 30 days.

  6. Inheritance tax deadline: While not directly related to CGT, it's worth noting that inheritance tax (if applicable) is due within six months of the person's death.

These deadlines apply to UK residents. Non-residents may have different reporting requirements and deadlines. It's always advisable to check the most current HMRC guidelines or consult with a tax professional to ensure you're meeting all necessary deadlines and requirements.

Are you thinking about the tax implications of your inherited property? Navigating capital gains tax on inherited property can be complex, but you don't have to face it alone.

If you need more information about capital gains tax on inherited property or require assistance, we at dns tax are here to help. Our expert team of tax advisors specialises in capital gains tax and inherited tax services. We can guide you through the intricacies of:

  1. Calculating potential capital gains tax

  2. Identifying applicable exemptions and reliefs

  3. Understanding reporting requirements and deadlines

  4. Exploring strategies to minimise your tax liability

  5. Ensuring compliance with HMRC regulations

Our personalised approach means we'll consider your unique circumstances to provide tailored advice and solutions. Whether you're planning to sell, rent, or keep the inherited property, we can help you make informed decisions to optimise your tax position.

Don't let tax concerns overshadow your inheritance. Contact us today at 0333 2422 572, email dnstax@dnsaccountants.co.uk, or book a free consultation. Our friendly experts will be happy to discuss your specific requirements and provide tailored solutions.

About the author
Blog Author

Siddharth Agarwal
I am a Chartered Tax Advisor (OMB) and ACCA. I have 9+ years of experience in owner-managed business taxation issues, company reorganisations, property taxation, and succession planning. I also work with private clients on bespoke tax planning strategies for trusts, residence status, and non-residents. I aim to fulfil my professional duties towards my clients and keep them satisfied, my utmost priority. I believe in establishing and maintaining businesses and personal relationships as the key to mutual growth.