The term "probate" refers to the legal process of managing a deceased individual's assets. When combined with "property," it describes real estate left behind that must go through probate to be transferred to heirs or beneficiaries. The responsibility for administering the probate process generally lies with the personal representatives named in the deceased's will, provided the probate application is successful.
As part of this process, the personal representatives must consider various tax implications, primarily capital gains tax (CGT), stamp duty land tax (SDLT), and, most significantly, the inheritance tax (IHT). As we have already dealt with the probate application procedure in our article Inheriting a House in the UK, we will focus on other scenarios around the probate property in this one. This article will also explore tax implications when the recipient of the property later sells such a property.
Immediate Taxes on Inheriting a Probate Property
Capital Gains Tax (CGT)
Capital gains tax is charged to individuals who make chargeable disposals in the same tax year. However, transfers resulting from death are not considered chargeable disposals for CGT purposes, and therefore, CGT does not apply to the inheritance of a property.
Stamp Duty Land Tax (SDLT)
Probate properties inherited via the deceased will do not attract any Stamp Duty Land Tax. This exemption applies even if the outstanding mortgage on the property is transferred to the recipient upon the person's death.
However, if no one is named in the will and the personal representative decides to sell the property instead, SDLT will apply to the purchaser. However, there are reliefs in place that, if applied, can reduce the SDLT to nil or a minimum, depending on which reliefs the transactions become eligible for. Full relief is given to properties bought by a company or a partnership with a company as one of the partners, and the property has been the deceased's main residence in the past two years.
However, these are not the only conditions to which the relief is subject. The details of the full and partial relief conditions are discussed in our article, Stamp Duty Land Tax Relief for Probate Properties.
Inheritance Tax (IHT)
Unlike CGT and SDLT, there are no exemptions from inheritance tax. It is charged to the deceased's estate at 40%. The deceased’s estate may include assets owned by them at the time of death, such as cash, properties, shares, etc. If the deceased’s estate only contains a property, IHT is payable on it alone.
The chargeable value of the property may be reduced by the nil rate band (NRB) of £325,000. However, if the deceased has made any gifts in the last seven years before death, the nil rate band may be further reduced, and more tax is payable. Additionally, if the property is residential and is left to the direct descendants of the deceased, a residential nil rate band (RNRB) becomes available, further reducing the value to which the IHT applies. The available RNRB is the lower of:
- £175,000 and
- the value of the property minus the outstanding mortgage.
Use our Inheritance tax calculator for swift computation.
If inheriting a property means an individual owns two houses, they must elect one as their main residence and inform HMRC within two years. The election of a main residence is crucial as it is only the main residence that will attract Private Residence Relief (PRR) in the future.
If the property is inherited from a trust, the recipient becomes the beneficiary, and the trustee, as the legal owner, is responsible for paying tax on any income the trust generates. In the case of bare trusts, the recipient assumes both the beneficiary and legal ownership roles and is responsible for any tax on the trust's income.
Tax Implications for the seller of an Inherited Property
When an inherited property is subsequently sold, capital gains tax (CGT) does get triggered if the property has increased in value since the inheritance. As with other disposals, the capital gain on the disposal is calculated as the difference between the sales proceeds and the relevant base cost. However, in the case of inherited properties, the applicable base cost is the value of the property on which the IHT was initially paid, also referred to as the probate value.
It should be noted that taxpayers cannot escape the CGT liability by gifting the property or selling it at a price below the market value. Such transactions are deemed 'arms-length transactions', and the property's market value at the date of gift will be considered the sales proceeds for the CGT computation, irrespective of the amount paid for the property.
Example
On 26 January 2000, Dan purchased a residential property for £80,000. He died on 18 September 2021, and his son, Abhi, inherited the property. On that date, the property had a market value of £500,000 (probate value). Even though the property's ownership is transferred due to the inheritance, there are no CGT implications as the on death is an exempt disposal for CGT purposes.
Fast forward to 20 March 2024, when Abhi sold the property for £700,000, he must consider CGT implications on the increased value of the property. At this disposal, the base cost for the property is £500,000. Therefore, the capital gain on the disposal is calculated as follows:
Sales Proceeds | £700,000 |
Less: Base Cost (Probate Value) | (£500,000) |
Net Chargeable Gains | £200,000 |
Less: Annual Exempt Amount (AEA) | (£3,000) |
Taxable Gains | £197,000 |
Depending on the nature and use of the property, the disposal may qualify for the Private Residential Relief (PRR).
Assuming Abhi is a higher-rate taxpayer and that he never occupied the property as his main residence, the rate applicable for this property is 24%. Consequently, Abhi will pay a capital gains tax of £47,280 (24% of 197,000).
Tax Implications for the buyer of an Inherited Property
Unlike CGT, SDLT is a tax charged to property buyers in England and Northern Ireland. Regardless of how the seller initially acquired ownership of the property, the buyer pays SDLT at the purchase price of the property.
Another contradiction between SDLT and CGT is that it is possible for individuals to escape SDLT or pay lower SDLT by making the transfer at a price below the market value. The rates vary depending on the buyer's residency status and whether the buyer is an individual or a company. For instance, the rates applicable to non-residents are 2% higher than those applicable to UK residents. The relevant rates are for individuals who own no residential property, and it is their first home.
Purchase Price | SDLT Rates [UK Residents] | SDLT Rates [Non-UK Residents] |
|---|---|---|
Up to £250,000 | 0% | 2% |
Above £250,000 and up to £925,000 | 5% | 7% |
£925,001 to £1.5m | 10% | 12% |
Above £1.5m | 12% | 14% |
In addition, first-time buyers buying their property for less than £625,000 can claim the first-time buyers' relief. However, individuals who own another property will pay an additional 5% surcharge on the above rates.
It is worth noting that if the inherited property has no outstanding mortgage and is gifted without consideration, there will be nil SDLT liability as there is no connected person rule, as with CGT. However, if the property buyer is a company, the connected person rule applies, and SDLT will be payable at the property's market value on the transfer.
The rates and potential reliefs from higher rates are detailed in the article, "Stamp Duty Land Tax on Limited Companies".
Conclusion
Handling the tax implications of probate properties requires careful attention to various tax laws, including CGT, SDLT, and IHT. While inheriting a property can be free from immediate CGT and SDLT liabilities, selling the property or transferring it to a company triggers tax considerations that must be addressed. Personal representatives and beneficiaries should seek professional advice to comply with legal obligations and minimise tax exposure. Understanding the tax rules surrounding probate properties is essential to making informed decisions, particularly regarding these assets' potential sale or transfer.
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