How To Avoid Capital Gains Tax On Inherited Property UK

If you recently inherited property or anticipate doing so in the future, it's understandable that you've developed a sudden interest in Capital Gains Tax!

This tax has come as a shock to thousands of people who didn't realise the potential implications when inheriting a house from a loved one. In many cases, people aren't aware that they have to pay Capital Gains Tax at all, or they don't realise how much CGT they will have to pay.

However, you have an advantage; you're reading this blog now, which puts you ahead of the game! Not only will you learn all about your CGT liability, but you'll also discover methods of reducing your tax burden, and maybe even eliminating it altogether.

So, take a few minutes to read and digest the Prescient Accounting guide on avoiding Capital Gains Tax on inherited property in the UK, and you could save yourself a substantial amount of cash!

What Is Capital Gains Tax, Exactly? 

Think of CGT as a levy on the profit you make when you dispose of an asset, such as shares, property, or even valuable collectibles worth more than £3,000. It's essentially the difference between the purchase price and the disposal value. The government then takes a slice of that profit.

For example, if you buy or inherit a painting, coin collection, antique furniture, jewellery, etc., and you make a profit (gain) from selling or otherwise ‘disposing’ of it, you may be liable for CGT.  

Do I Always Pay CGT? 

Thankfully, no! Everyone gets an annual Capital Gains Tax allowance which acts as a tax-free threshold. This was reduced from £12,500 to £6,000 in 2023, although the new rate will be £3,000 as of April 6, 2024.  

As long as your total capital gains for the year stay below this amount, you won't owe any CGT. However, if your profits exceed the allowance, you'll only pay tax on the extra amount. 

What About Inherited Assets? 

Inheriting something is a privilege, but it can also have tax implications. The good news is that inherited assets generally receive a helpful tax adjustment. Their value is considered to be their market value on the day you inherit them, which can significantly reduce the capital gain you'll pay if or when you eventually sell. 

CGT Liability On Inherited Property

You'll need to bear with us, as CGT can be complicated. However, we'll do our best to explain it in everyday terms to avoid confusion...

The amount of CGT you pay on inherited property in the UK depends on a few factors: 

• The property's value at inheritance Vs. selling price - You only pay CGT on the total gain made from selling the property, which is the final sale price of the property minus the value at inheritance (also minus additional costs such as renovation). You can also subtract estate agents and solicitors fees, but general maintenance costs (like decoration) can't be included.
• Your annual CGT allowance - Everyone gets an annual tax-free allowance for capital gains. As long as the total taxable gain from selling the property falls within this allowance, you won't pay Capital Gains Tax. 

Here's how the tax rate is applied: 

• No CGT if - The gain is less than or equal to your annual personal allowance. 
• Basic rate Income Tax band (18%) - If the gain exceeds the allowance but is below £50,000 (subject to change). 
• Higher rate Income Tax band (24%) - If the gain surpasses both the allowance and £50,000.

As always, the tax people seem to enjoy making things as complex as possible, so let's try to explain how HMRC works things out...

• Tax-free allowance - Imagine you get a certain amount of money you can earn each year without paying income tax.
• Taxable gains - This refers to the profit you make when you sell something like a property or investment. 
• Overall taxable income - This is all the money you earn in a year that the government taxes, after subtracting things like work expenses. 

Now, the confusing part! 

They subtract your tax-free allowance from your taxable gains. This basically means they're treating some of your profit like regular income. 

Then, they add this adjusted amount (taxable gains minus allowance) to your overall taxable income. 

Why Do They Do This? 

They're determining whether your total income, including the profit you made, falls within the basic rate tax band.

The basic band for income tax relates to your total earnings. If your total income for the tax year (including the adjusted profit) stays within this basic band, you might not pay any income tax on that profit. 

Here's a simplified case study to illustrate the CGT process:

• You inherit a residential property from a relative. 
• The property's market value on the inheritance date (probate value) is £350,000. 
• You decide to sell the property and achieve a selling price of £380,000. 
• You are a basic rate taxpayer (currently 18% tax rate). 

We can now move on to this step-by-step guide that breaks down the process...

Calculating The Capital Gain 

• Gain from Sale - Selling Price (£380,000) - Probate Value (£350,000) = £30,000 capital gain. 

Assessing CGT

• Annual Allowance - Using the new annual CGT allowance of £3,000 (previously £6,000). 

Since the gain (£30,000) exceeds the annual allowance (£3,000), you will have a taxable amount. 

• Taxable Gain - Capital Gain (£30,000) - Annual Allowance (£3,000) = £27,000 taxable gain. 
• CGT Rate - Basic rate taxpayers will pay tax at the basic rate of 18%. 

Calculating Capital Gains Tax Owed

• CGT Payable = Taxable Gain x Tax Rate 
• CGT Payable = £27,000 x 18% = £4,860 

The CGT payment deadline is sixty days after the completion of the sale. Otherwise, penalties will be applied by HMRC.

Conclusion

In this case study, you would owe £4,860 in Capital Gains Tax on the sale of the inherited house. 

Now, that's almost five grand that you need to pay to the government. And if there's an ethical and legal means to avoid paying it, why shouldn't you take advantage of this?

After all, the above example is simplified, and there may be other costs incurred. Also, if the gain was more significant (say, around £70k), you're looking at a Capital Gains Tax bill of about £12,000 under the current rates.

With this in mind, we'll move on to discover how you can avoid Capital Gains Tax or reduce the amount...

Inherited Property As A Main Residence

When you make the inherited property your main or 'principal' residence, you can usually avoid paying Capital Gains Tax (CGT) on any profit you make if you decide to sell it later. 

This is because of something called Private Residence Relief (PRR), which basically exempts your main home from CGT. 

Check out: How To Avoid Paying VAT On Commercial Property

What’s The Catch? 

Even if you already own another property, you can only claim Private Residence Relief for one at a time. 

You need to tell HMRC which property is your principal residence within two years of inheriting the new one, as this helps them keep track of things. 

So, What Should You Do? 

Take some time to seriously consider whether you want to live in the inherited property yourself. 

If you do, then you need to officially make it your main home and notify HMRC within two years to claim PRR on any future sale. 

Now, it might occur to you to advise HMRC that this is your main residence even if it's not. After all, how will they know?

However, in all seriousness, this is not a wise move!

HMRC normally wouldn't conduct a physical check to see if you're living at your principal residence when claiming Private Residence Relief (PRR). However, they do rely on evidence and have ways to assess your claim.  

Essentially, there are five main criteria that you must meet in order to be successful:

1. Throughout your ownership, the property must have been your primary dwelling, the roof over your head. Think of it as your central base, the place you call home. 
2. You can't have been away for extended periods, except for allowed reasons like temporary work placements with specific accommodation. 
3. The size of the land surrounding the property, including any buildings, needs to be within a reasonable limit - currently, that's no more than half a hectare. 
4. No part of the property should be dedicated solely for business purposes. 
5. The property can't have been purchased purely for financial gain; it genuinely needs to have been intended as your residence. 

The responsibility lies with you to demonstrate the property was your principal residence. 

Here’s how the system works: 

Focus On Intention And Evidence  

HMRC looks for evidence that you intended the property to be your main home. This could include things like: 

• Registering to vote at the address 
• Receiving mail at the same address
• Having your utilities connected 

Length Of Stay Matters 

While there's no set timeframe, very short periods of occupation might raise questions. Conversely, returning to the property after a temporary absence strengthens your claim. 

Exceptions 

There are situations where HMRC might investigate further, such as: 

• Claiming PRR for multiple properties 
• Significant inconsistencies in your evidence 

It's important to be truthful! Trying to deceive HMRC about your main residence can lead to penalties and tax charges. You’ll probably be fined, and you’ll be expected to pay the CGT you tried to avoid.  

You also may face criminal prosecution for fraud, depending on the severity of the case.

Selling Inherited Property Immediately (Or Soon After)

CGT is only charged on the profit you make when selling personal possessions or assets, like property, worth £So, the closer the selling price is to the value of the property when you inherited it, the less likely you are to pay any tax. 

If the property hasn't increased much in value since your inheritance, selling it quickly can be a good strategy. This minimises the potential "capital gain" (the difference between the selling price and inheritance value) and, therefore, the potential CGT liability. 

Be Aware!

• Property prices can fluctuate. Even a short wait might see the value rise, meaning a higher CGT bill. 
• Selling quickly often means taking a lower price, which could impact your overall gain/loss. 

The Bottom Line

Selling soon after inheritance can minimise CGT, but it's not always the best option. Weigh the potential tax benefit against the possibility of getting a better price if you wait. 

Recommendation

Consider talking to a qualified surveyor to get an accurate valuation of the property and a property agent for market advice. This will help you decide the best time to sell and maximise your profit (or minimise your loss). 

Transferring Ownership To Spouse/Civil Partner

The beauty of transferring inherited property to your spouse is that you generally won't pay Capital Gains Tax. This applies regardless of how much the property's value has increased since you inherited it. 

The Tax Man Looks To The Future! 

While you're off the hook for CGT, your spouse might have to pay it if they decide to sell the property later. The tax is calculated based on the difference between the selling price and the value of the property when it was transferred to them (not the inheritance value). 

Here's A Breakdown As A Guide

• You inherit a property worth £100,000. 
• You transfer ownership to your spouse. (So, no CGT for you!) 
• The property value increases to £150,000. 
• Your spouse sells the property for £150,000. 
• In this case, your spouse might have to pay CGT on the £50,000 gain (selling price - transfer value). 

Additional Considerations 

It's important to keep accurate records of the property's transfer value for future reference. 

This tax relief applies to married couples or those in a civil partnership only.

Gifting The Property

Gifting it can be an option, but there are tax implications to consider: 

Gifting To Charity 

Donating the inherited property to a registered charity in the UK is a great way to avoid Capital Gains Tax (CGT) altogether. Since charities don't pay CGT, the entire transaction is tax-free for you. 

Gifting To Individuals 

Gifting the property to a friend, family member, or other individual can be a generous gesture. However, the tax situation is a bit more complex: 

• No immediate CGT for you - Just like transferring to a spouse, you generally won't pay any CGT when gifting the property. 
• The Tax Burden Shifts - Here's the catch. The recipient inherits your "base value" for the property when calculating their future CGT liabilities.  

In essence, if the property's value has increased since you inherited it, the recipient might face a higher CGT bill if they sell later. 

Also, their base value for CGT purposes becomes the value at the time you gifted it, not the inheritance value. 

Here's An Example 

• You inherit a property worth £100,000. 
• The property value increases to £150,000 by the time you gift it. 
• The recipient sells the property for £150,000. 
• In this scenario, the recipient might have to pay CGT on the full £150,000 gain (selling price) because their base value is the £150,000 you gifted it at, not the original £100,000 inheritance value. 

Before You Gift 

• Consider the potential CGT implications for the recipient. 
• Discuss the situation with them to ensure they understand the tax consequences of accepting the gift. 
• Talking to a tax advisor can help you navigate the specifics and ensure everyone involved is aware of the tax implications. 

Will I Have To Pay Inheritance Tax?

Inherited property itself isn't subject to Inheritance Tax in the UK, whether it's rented out or used as a main residence. However, the property's value is included in your estate for tax purposes. This means it can affect whether the deceased person's estate owes Inheritance Tax. 

Take a look at this breakdown: 

• Inheritance Tax on the Estate - Inheritance Tax is only applied to the total value of your estate that exceeds the nil rate band (currently £325,000 as of April 2024). IHT is usually only paid by the deceased's estate, not the person who inherits.
• Rented Property's Value - The market value of the rented property is added to the value of your other assets to determine your estate's total value. 

So, if your estate, including the rented property, is below the nil rate band threshold, you will avoid Inheritance Tax. However, if the total value exceeds the threshold, the rented property's value contributes to the taxable amount. 

It's also worth pointing out that you will need to pay income tax if you inherit a buy-to-let or holiday rental property once you begin to receive rental income.

So, now you have everything you need to tackle the thorny issues of Capital Gains Tax!

Hopefully, you can use this to avoid paying CGT or reducing the amount, but if you need further advice, our specialists are here to guide you.