Do you pay Capital Gains Tax on inherited property?

Inheriting a house, or any type of property, can drastically increase the value of your own estate, but it can also make you liable to pay higher taxes. Specifically, if the home you’ve inherited has gone up in value since you inherited it, you may have to pay capital gains tax if and when you decide to sell it. This can produce a fairly hefty tax bill if there’s been a considerable increase in the sale value, however, there are a few ways you can get yourself off the hook for paying capital gains tax on inherited property, as we’ll outline below.

What is capital gains tax?

Capital gains tax (CGT) applies when an investment sells for more than its original purchase price. We usually think of capital gains tax in terms of selling stocks from an investment portfolio, however it also applies to other forms of investments such as property or tangible assets.

With capital gains tax, you are taxed on the profit - or “gains” - you make on the sale, rather than the whole amount you receive. Say, for instance, you bought a piece of artwork for £6,000 and later sold it for £36,000, this means you gained £30,000. This is the amount that you will pay CGT on.

How much CGT you pay depends on whether you are a higher or additional rate taxpayer (i.e., an income of over £50,270 per annum) or a basic rate taxpayer (i.e., an income of £50,270 or less per annum). And, if you fall into the latter category, the rate will depend on the size of your gain, your taxable income and whether your gain is from residential property or other assets. Typically, if your gains don’t push you into a higher income band, you’ll pay 18% on your gains on residential property and 10% on gains for everything else. Higher and additional rate taxpayers, (or basic rate taxpayers where the gain, when added to income, falls wholly or partially above the basic rate band) meanwhile, pay a fixed percentage of 28% on gains for property and 20% on gains from other assets.

What is the capital gains tax allowance?

The capital gains tax allowance for 2022-23 is £12,300. This allowance refers to the amount of gains in total you can make from an asset or property in a tax year, before you are liable to pay tax on it. If your assets are jointly owned with another individual, you can combine your allowances, effectively doubling the gains you can make to £24,600, before any CGT is owed.

Note that you are not able to carry forward any unused CGT allowance from the previous tax year.

How can I avoid capital gains tax on inherited property?

There are only two ways to avoid paying capital gains tax on an inherited property. These are outlined below:

  • Make the inherited property your principal residence

Through doing this, you avoid paying capital gains tax when you sell it at a later date. This is because the rules state that you are not liable to pay CGT on a home that is your principal residence (so effectively your main home), so long as you have lived in it the entire time you’ve owned it (however, there are allowable absences including the last 9 months of ownership and work-related absences). This is also on the condition that you do not let any of the home out, either for living or business purposes. Please keep in mind, however, that letting relief might be available if the letting of the property has been the taxpayer's main or only property.

  • Sell or gift the property as soon as you inherit it

This means you avoid waiting for the property to appreciate any further. For example, if at the time of inheriting and the time of selling the value of the property is the same, then you will not need to pay CGT. However, this can be a problematic option if it was the wish of the deceased that you live in the property or keep it in the family.

Note that if you decide to rent out the property, you will be charged income tax, since you are using it as a means of generating an income.

How do you calculate capital gains tax on inherited property?

Calculating capital gains tax on inherited property is no easy task. Fortunately, we’ve broken it down into clear and easy steps below:

  • Calculate your total gain

Total gain is the value when you sold the property minus the value when you inherited it, minus all additional costs spent on the property, including any renovations or improvements.

Total gain = (value of property when sold - value of property when inherited) - additional costs

  • Deduct your capital gains allowance to get your taxable gain

As mentioned above, the capital gains tax allowance for 2022/2023 is £12,300. This is the total gain you can make from all your assets or property before you have to pay CGT. If you haven’t used any of your CGT allowance on other assets, then you will have £12,300.

Taxable gain is the total gain minus capital gains allowance.

Taxable gain = (total gain - capital gains allowance)

  • Calculate your tax rate and multiply by taxable gain to get your CGT liability

Your tax rate is worked out according to your income. There are four tax rates bands:

Band

Taxable Income

Personal Allowance

Up to £12,570

Basic rate

£12,571 to £50,270

Higher rate

£50,271 to £150,000

Additional rate

Over £150,000

If you’re a higher or additional rate taxpayer, you pay:

  • 28% on your gains from residential property
  • 20% on your gains from other chargeable assets

If you’re a basic rate taxpayer, you pay 10% on your gains (or 18% on residential property).

The total CGT that you have to pay is your taxable gain multiplied by your tax rate.

Total CGT = (taxable gain x tax rate)

If maths isn’t your strong suit and you’re feeling overwhelmed by all these calculations, HMRC has a capital gains calculator which can do all the work for you.

Extra tips for how to avoid capital gains tax on inherited property

  • Transfer assets to joint names

If you’re married or in a civil partnership, you can transfer assets into joint names. This means you can combine your tax-free allowance making it £24,600 in 2022. However, any transfer you make has to be a genuine gift.

  • Nominate different principal homes if you're unmarried/not in a civil partnership

Unmarried and non-legally bound couples can each make a different property their main home. So, if you inherit a property and want to avoid paying capital gains tax on it, you can make it your main property, while keeping your former property as your partner’s main home. This means you can benefit from tax relief on both. Married couples and civil partners, on the other hand, are legally obligated to nominate one single home as their primary residency.

So in summary while capital gains tax is the tax you pay on any gains you make from assets or property appreciation, there are two main ways you can avoid paying capital gains tax on inherited property:

  • Making the inherited property your main residence
  • Selling or gifting the property immediately after inheriting before it has the chance to appreciate.

How can we help?

If you’re concerned about how much tax you may need to pay on any inherited estate or you simply want to discuss ways you might be able to minimise your tax bills, why not get in touch and see if we can help. We can work with you to advise on the best way to minimise the tax payable on your estate, while helping you build your wealth.

With tax and the regulation around it constantly changing, it pays to have an expert financial adviser available to help you stay on top of your taxes, come what may.
If you want to find out more about how we can help you navigate capital gains tax and inheritance tax, please get in touch and arrange a free consultation.

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Please note: that the Financial Conduct Authority (FCA) does not regulate estate planning, tax or trust advice.

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