How to Avoid Capital Gains Tax On Inherited Property

We’ve all seen the Hollywood version of inheriting a big, ancient property full of antiques, massive portraits full of our heretofore unknown ancestors and a whole new history. But what those films don’t show us comes later – and it comes in the shape of piles of paperwork and taxes.

The reality show-version of the same story would include lawyers, accountants, and the inheritor calling up art galleries begging them to please buy one of those massive paintings. And the scene where that surviving family member has to pay the Capital Gains Tax?

Our new homeowner dissolves into tears. Fade to black. 

To avoid being this dark, disturbed version of yourself, it’s important that you understand inheritance tax, Capital Gains Tax, (CGT), and how to make it work for you, not against. That’s why we put together this guide to help you navigate the scary journey into inheriting property or funds. 

Keep scrolling to see how you can keep what’s yours and keep it legal. 

According to Taxfoundation.org, “The U.S. has the fourth highest estate or inheritance tax rate in the Organisation for Economic Co-operation and Development (OECD) at 40 percent; the world’s highest rate, 55 percent, is in Japan, followed by South Korea (50 percent) and France (45 percent).

What is the inheritance tax?

 Most people won’t face any inheritance tax, or a fee charged to someone who inherited an estate from someone who passed away. The tax only kicks in if your new house, bank account or possessions equal £325,000 or more. 

Once the total exceeds this amount, you’ll be expected to pay a large amount of your inheritance to HMRC. They charge 40 percent, but there are ways to reduce that amount. 

No matter what, always report what you inherit to the British government. That said, there are ways to keep your total tax dollars down so HMRC can’t claim all of it.

• Stay within the threshold – If you give any amount above the official threshold of £325,000 to someone eligible to receive it as a gift and sidestep the tax. The HMRC allows you to transfer the money to “spouse, civil partner, a charity or a community amateur sports club.”
• Give away your house – If your inheritance exceeds the threshold but doesn’t exceed £500,000, you can donate your primary residence and then keep all of the money. Your biological, adopted, step, foster or grandchildren are possible recipients to receive the property.
• Make a donation – Leave 10 percent or more of your net value to charity and you can reduce, though not erase, your inheritance tax. Have your accountant help you find the correct amount to give away and you’ll only have to pay the government 36 percent.

Your executor or the person left in charge of the estate and money is responsible for paying any taxes to the government. The money comes directly from the estate and not from your personal or business account. 

Do I pay Capital Gains Tax if I sell an inherited property? 

So that’s all fine and good, but what happens if you decide to sell? Depending on what you make, you may have to pay Capital Gains Tax, or a tax on a profit made during a sale.

None of your deceased family member’s assets already in the family will be eligible for CGT. These are considered unrealised gains by the government and not something up for taxation. 

If you inherit a property from the deceased worth £200,000 and then sell it for the same value, you won’t pay a CGT. The extra fees you need to pay your estate agent and any other professional who helps with the sale is considered a kind of tax. 

However, if you inherit that house, wait two years, and then sell it for £400,000, you made a profit. Now you owe some CGT.

How much tax will I pay when I sell the house I inherited?

The amount of CGT you owe on the inherited property’s sale is a percent of your profit from the sale, minus the current personal allowance from HMRC, (£12,570 in 2021). So, we can take our example house worth £200,000 and work out what’s owed. 

• Value at the time you inherited the house:  £200,000
• Solicitor’s fees:  £1,000
• Updates and improvements to the property, (repairs, new kitchen cabinets, etc):  £10,000
• Other fees, (realtors, surveyors, appraiser):  £5,000

You sell the house at  £400,000 and earn a profit of  £371,430 You can’t be taxed for  £12,570 of that, so that leaves  £358,860. 

How much the government takes from that depends on your earnings in the past year. For someone earning £25,000 a year, the annual tax is £4,336 and puts you in a tax band of 18 percent. 

Now you need to figure out how much tax you owe HMRC. Here’s how they’ll charge you. 

Because you earn about £25,000 a year, your CGT falls into the tax band of 18 percent. For the first £25,270 you made on the sale, they get £4,548.59.

This was a profitable sale, so the remaining £146,430 gets taxed at your normal rate plus ten percent, or 28 percent. That total comes to £41,000.40. 

The total Capital Gains Tax comes to £45,549. 

All of this can be calculated with the HMRC Capital Gains Calculator. After you answer questions about your expenses, how you came to be the owner of the property and how much it went for, you can get the exact amount you need to pay.  

How to apply for deductions from Capital Gains Tax on inherited property

Looking at the above sale, it’s clear the government will take a large part of your inheritance simply because you gained so much more from the sale. To keep that number down, make sure to keep receipts from any professionals who help out during the process so you can claim the expenses.

Here’s a quick list of what you can deduct from your CGT with the proper documentation:

• Any fees paid to your real estate agent
• The cost of solicitors, surveyors, or appraisals on the property
• What you pay to improve the property. This could be an extension, an update to the kitchen, a new fireplace, etc.
• Any other buying or selling costs you incur during the sale.

The big cost you can’t deduct is maintenance to the property. If you need new wiring or put in copper pipes, don’t try to claim those expenses. 

You also cannot claim your mortgage interest on your taxes. 

If you aren’t sure how to manage your inherited property and all the costs, taxes, and general headaches, consider hiring someone to manage the numbers for you. A professional accountant with experience in inheritance tax, property tax, and Capital Gains Taxes can be a God send at times like these.

Capital Gains Tax and renting

Maybe you don’t want to sell that big country estate but rather let rooms and space for people to live and work away from the city. What taxes would you need to pay then?

According to the official UK government website, this is allowed and you will have to pay tax on any rent income you earn over £1,000. You need to register for their Self Assessment service to help you calculate exactly what you owe based on your new income. 

Rules for renting properties in the UK are changing based on the new market, new attitudes about shared living and working spaces and in an effort to close long-standing loopholes. Make sure you consult with a professional before you set up your new rental business to help you understand the new regulations. 

Like that sale, you can use lots of items as deductions on your taxes. Domestic items like furnishings for your rented rooms, items in the kitchen and window dressing can all help get your taxes down. 

Other costs you can deduct include:

• Letting agents’ fees
• Legal fees for a year or less
• The cost of an accountant
• Buildings/Contents insurance
• Maintenance or repairs to the property
• The cost of gas, water, and electricity
• Council taxes
• Paid services such as cleaning or pool maintenance
• Other direct costs like advertising vacant rooms or basics like stationery or phone service

Renting is not to be taken lightly. Running a property requires a solid property manager who you’ll have to hire and pay if you can’t do it yourself, so do a thorough rundown of costs and requirements before renting out any space.

Conclusion

No matter what you decide, you need to have a good professional working for you to help you calculate costs, pay the government and make sure you get the profits you deserve. It’s great to inherit something valuable, but it feels incredible to make the most of that amazing gift. 

Are you ready to get your new estate in order? Book a call with us today to get started.