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How is Capital Gains Tax Paid on Inherited Assets?

The loss of a loved one takes an emotional toll. Something that can be equally challenging is navigating the various arrangements you may need to make afterwards, including dealing with inheritance matters. In the UK, you don’t usually have to pay any immediate tax on the assets you inherit. However, you might have to pay certain taxes in a few scenarios, some of which we will outline in more detail in this guide.

Rhea Tibrewala
· 7 min read

The loss of a loved one takes an emotional toll. Something that can be equally challenging is navigating the various arrangements you may need to make afterwards, including dealing with inheritance matters. In the UK, you don’t usually have to pay any immediate tax on the assets you inherit. However, you might have to pay certain taxes in a few scenarios, some of which we will outline in more detail in this guide.

What Different Taxes Apply to Inheritance?

There are three main types of tax that you may need to pay related to inheritance. Each of them has exemptions and a method of calculation which can make them a little tough to understand. What’s more, dealing with them at the same time can be even more complicated. However, we’re here to spell out the differences for you.

  • Inheritance tax is a levy charged on the possessions, property, or money of someone deceased. If applicable, it is deducted from the estate of the deceased by the executor of the will (or the administrator if there's no will).
  • Capital Gains Tax (CGT) is a tax paid on the profit generated by the sale or disposal of an inherited asset (such as property, personal possessions, shares, or business assets). The profit is calculated by deducting the original cost, incidental costs of buying or improving the asset, and any remaining tax-free allowance from the market value of the asset. We will explain this in more detail later.
  • Income Tax is tax paid on your income. You may have to pay income tax on profits generated from assets you retain from your inheritance, such as rent from a property or dividends from shares. You may also need to pay income tax on behalf of the deceased if they owe any tax to the government.

Differences between Inheritance Tax and Capital Gains Tax

The main differences are the scenarios in which each type of tax become payable, as well as the rate at which the tax is calculated. Let’s look at each in more detail.

When Does One Have To Pay Inheritance Tax?

As mentioned earlier, inheritance tax is deducted from the estate of the deceased. However, inheritance tax does not apply if:

  • The value of the deceased’s estate is below the threshold of £325,000.
  • Everything over and above the threshold of £325,000 is left to the spouse or civil partner of the deceased, or a charity or community club.

If the deceased has left their home to their children or grandchildren (including stepchildren, adopted children, or foster children), then the abovementioned threshold can be increased to £500,000.

Additionally, if the estate of the deceased is worth less than their permitted threshold, any unused threshold can be added to their spouse or civil partner’s threshold when they die. This means that in theory, their threshold can be as much as £1 million.

How Much Inheritance Tax Do You Need To Pay?

Inheritance tax differs from estate to estate. The standard rate of inheritance tax is 40%. However, depending on various allowances available to the estate, this can be reduced. Yopa estimates that the average estate pays just 6% in inheritance tax.

The main reason for this is that the tax is charged only on the part of the estate that exceeds the permitted threshold of £325,000. So for example, if the estate of the deceased is valued at £600,000, then the Inheritance tax payable is :

40%       x                            (£600,000 - £325,000)    =             £110,000

 

Standard tax rate             Difference between value
of estate and threshold

Additionally, in some instances, the estate can pay a reduced rate of 36% for inheritance tax in case the deceased leaves 10% or more of the net value of the estate to charity.

When Do You Have to Pay Capital Gains Tax?

Capital Gains Tax is payable on profits generated from the disposal of an inherited asset. Disposal of an asset implies that you have either sold it, given it away as a gift, exchanged it, or received any compensation or payout related to it.

The assets that you may have to pay CGT on include:

  • Personal possessions worth £6,000 or more (excluding a car).
  • A property that is not your primary residence.
  • Your primary residence in case you have let it out, used it for business, or it is a large home.
  • Shares that are not in an ISA.
  • Business assets.

You do not have to pay CGT on:

  • Any dividends generated from ISAs. However, this is subject to whichever of these occurs first:
    • Until the administration of the deceased’s estate is finalised.
    • The ISA account is closed.
    • Three years after the ISA holder's death has elapsed.
  • Earnings from government bonds.

Most importantly, you only have to pay CGT on any profits you earn over and above your tax-free allowance (also known as the Annual Exempt Amount). At present, the tax-free allowance for CGT is £12,300 (or half that amount for trusts).

How Can I Calculate the Taxable Amount For Capital Gains Tax?

Calculating the taxable amount for CGT can be tricky since the tax is only payable on profits generated over and above the Annual Exempt Amount.

Additionally, allowable deductions can reduce your tax liability. These include any costs or fees associated with inheriting the asset, such as solicitors' or estate agents' fees, and expenses associated with home refurbishment. The only types of expenses considered as allowable refurbishment costs are those related to necessary repairs, replacement or renewals. You can't claim for frivolous decorations or general improvements and renovations! You can find further guidance on the HRMC website.

Let’s understand the calculation of the taxable amount with the help of an example.

Assume you inherit property worth £250,000 and sell it a few months later at a loss. In this scenario, you will not be liable to pay CGT, since you did not generate any income from its disposal.

However, if you had sold it for £300,000, then you would be liable to pay CGT since you had turned a profit of £50,000. Taking your Annual Exempt Amount of £12,000 into account, your total taxable amount would be £ 38,000. This is because you need to deduct your Annual Exempt Amount from the profit generated by the disposal of the asset.

£ 300,000       Sale value of the property

(-) £ 250,000       Inherited value of the property

£   50,000 Profit generated from the sale

(-) £   12,000       Annual Exempt Amount

                    £   38,000       Taxable Amount

Finally, the last dimension is accounting for any deductions that are applicable to reduce your tax liability. Assume that in the above example, you spent £5,000 on solicitors’ fees and another £2,000 on a valuation. The new calculation would be as follows:

£ 300,000       Sale value of the property

(-) £ 250,000       Inherited value of the property

(-) £     5,000       Solicitors’ fees

(-) £     2,000       Valuation fees

£   43,000 Profit generated from the sale

(-) £   12,000       Annual Exempt Amount

                    £   31,000       Taxable Amount

Once you account for any eligible deductions, the profit generated from the disposal of the asset reduces, thereby reducing your tax liability. You must be sure to keep the receipts of any associated expenses that might be eligible.

How Much Capital Gains Tax Will You Actually Need To Pay?

Once you have calculated the taxable amount, you can apply the appropriate rate of tax to it to know how much CGT you owe. The rate of tax depends on how much you earn (your annual personal income).

  • If you are a basic rate income taxpayer, the rate of CGT is 18% for properties or 10% for other types of capital gains tax.
  • If you are a higher rate income taxpayer, the rate of CGT is 28% for properties or 20% for other types of capital gains tax.

In case you can’t be bothered with the calculations, don’t worry! HRMC offers a handy online calculator that accounts for all the exemptions, deductions, varying tax rates, and more to help you quickly estimate how much CGT you will need to pay for any property or other assets that you inherited.

We would recommend using the calculator or getting the help of an experienced tax consultant to help you navigate these regulations and give you peace of mind in the interim.

Rhea Tibrewala

Rhea Tibrewala

Rhea has had over 5 years of experience in the finance sector, having worked as a digital marketing manager for leading financial institutions across multiple geographies. She is a tech fanatic, an avid reader, and enjoys travelling and music in her free time.
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