Learning Outcomes
After reading this article, you will be able to identify when beneficiaries become liable to Capital Gains Tax (CGT) on inherited assets, explain how probate value is used as the acquisition cost, outline the main steps in calculating CGT on inherited property, and apply key reliefs and exemptions. You will also understand the interaction between inheritance tax and CGT, and recognise common pitfalls relevant to the SQE1 exam.
SQE1 Syllabus
For SQE1, you are required to understand the tax implications for beneficiaries inheriting assets, especially regarding Capital Gains Tax (CGT) and income tax during estate administration. In your revision, focus on:
- the point at which CGT liability arises for beneficiaries inheriting assets
- the use of probate value as the acquisition cost for CGT purposes
- the calculation of CGT on disposal of inherited assets, including allowable deductions and reliefs
- the interaction between inheritance tax and CGT
- the main exemptions and reliefs available to beneficiaries
- practical issues such as partial disposals, mixed-use assets, and valuation
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- When does a beneficiary become liable to Capital Gains Tax on an inherited asset?
- What is the significance of the probate value for CGT purposes?
- Name two types of relief that may reduce a beneficiary’s CGT liability on disposal of inherited property.
- True or false? CGT is charged at the point a beneficiary inherits an asset from an estate.
Introduction
Beneficiaries inheriting assets during estate administration need to be aware of their potential liability to Capital Gains Tax (CGT). While inheritance itself does not trigger CGT, a taxable gain may arise if the beneficiary later disposes of the inherited asset. The calculation of any gain uses the asset’s probate value as the acquisition cost. Understanding when CGT applies, how to calculate it, and what reliefs or exemptions are available is essential for SQE1.
Beneficiaries and Capital Gains Tax on Inherited Assets
When Does CGT Liability Arise?
CGT is not charged when a beneficiary receives an asset from an estate. Instead, liability arises only when the beneficiary disposes of the inherited asset—by selling, gifting, or otherwise transferring it. Until that point, no CGT is due.
Key Term: disposal A disposal is any event where ownership of an asset is transferred, including sale, gift, or exchange.
Probate Value as Acquisition Cost
When a beneficiary inherits an asset, the asset is revalued for tax purposes at the date of the deceased’s death. This value, known as the probate value, becomes the beneficiary’s acquisition cost for CGT. Any gain is calculated by comparing the disposal proceeds with this probate value.
Key Term: probate value The market value of an asset at the date of the deceased’s death, used as the acquisition cost for CGT when the asset is inherited.
Calculating the Chargeable Gain
To calculate the gain on disposal:
- Start with the amount received on disposal (sale price or market value if gifted).
- Deduct the probate value (acquisition cost).
- Deduct allowable expenses (e.g., legal fees, agent’s fees, and costs of improvements).
- The result is the chargeable gain, which may be reduced by reliefs or exemptions.
Key Term: allowable expenses Costs that can be deducted from the disposal proceeds when calculating a chargeable gain, such as selling costs or capital improvements.
CGT Rates and Annual Exempt Amount
The chargeable gain, after deducting any reliefs or exemptions, is taxed at the beneficiary’s applicable CGT rate. The rate depends on the beneficiary’s income tax band and the type of asset (e.g., higher rates for residential property). Each individual also has an annual exempt amount, so only gains above this threshold are taxed.
Common Reliefs and Exemptions
Several reliefs may reduce or eliminate CGT liability:
- Principal Private Residence Relief (PPR): If the inherited property becomes the beneficiary’s main home, some or all of the gain may be exempt.
- Business Asset Disposal Relief: May reduce the CGT rate to 10% for qualifying business assets.
- Annual Exempt Amount: Each individual has a tax-free allowance for gains each tax year.
Key Term: Principal Private Residence Relief A relief that exempts all or part of the gain on disposal of a property used as the owner’s main residence.
Special Situations
Partial Disposals
If only part of an inherited asset is disposed of (e.g., some shares from a larger holding), the probate value and allowable expenses must be apportioned to calculate the gain on the part disposed.
Mixed-Use Assets
Where an inherited asset is used partly as a residence and partly for another purpose (e.g., a shop with a flat above), the gain must be split between the different uses, and different CGT rates or reliefs may apply.
Valuation Issues
Assets that are unusual or difficult to value (e.g., artwork, collectibles) may require a professional valuation both at the date of death and at disposal.
Interaction with Inheritance Tax
Inheritance Tax (IHT) is charged on the value of the deceased’s estate at death, while CGT is charged on the beneficiary’s gain when disposing of the asset. To prevent double taxation, the probate value is used as the acquisition cost for CGT, so any increase in value before death is not taxed twice.
International Aspects
Non-UK residents may be liable to UK CGT on disposal of UK residential property, even if the asset was inherited. Double taxation treaties and remittance basis rules may also affect liability.
Worked Example 1.1
A beneficiary inherits a house valued at £350,000 at the date of death. Two years later, they sell the house for £400,000, incurring £5,000 in estate agent and legal fees. What is the chargeable gain for CGT?
Answer: The gain is £400,000 (sale price) minus £350,000 (probate value) minus £5,000 (expenses) = £45,000. The beneficiary can also deduct the annual exempt amount before calculating CGT due.
Worked Example 1.2
A beneficiary inherits 2,000 shares valued at £10 each (£20,000 total) at the date of death. They sell 1,000 shares for £15 each (£15,000 total), incurring £200 in broker fees. How is the gain calculated?
Answer: The acquisition cost for 1,000 shares is £10,000 (1,000 × £10). The gain is £15,000 (sale proceeds) minus £10,000 (cost) minus £200 (fees) = £4,800. The annual exempt amount may further reduce the taxable gain.
Worked Example 1.3
A beneficiary inherits a property used as both a shop (60%) and a flat (40%). The probate value is £500,000. The property is sold for £600,000. How is the gain apportioned?
Answer: The total gain is £100,000. £60,000 is attributable to the shop (taxed at standard CGT rates), and £40,000 to the flat (may qualify for Principal Private Residence Relief if used as the beneficiary’s main home).
Exam Warning
For SQE1, remember that CGT is not charged when a beneficiary inherits an asset, but only when the asset is later disposed of. Do not confuse the date of inheritance with the date of disposal for CGT purposes.
Key Point Checklist
This article has covered the following key knowledge points:
- Beneficiaries are not liable to CGT when they inherit, but only when they dispose of the inherited asset.
- The probate value at the date of death is used as the acquisition cost for CGT calculations.
- The chargeable gain is calculated by deducting the probate value and allowable expenses from the disposal proceeds.
- Reliefs such as Principal Private Residence Relief and the annual exempt amount may reduce or eliminate CGT liability.
- Partial disposals and mixed-use assets require apportionment of acquisition cost and gain.
- Inheritance Tax and CGT are separate, but probate value prevents double taxation on the same increase in value.
Key Terms and Concepts
- disposal
- probate value
- allowable expenses
- Principal Private Residence Relief
