When someone dies their estate is valued for probate purposes before being distributed to the person’s heirs. It is then potentially subject to Inheritance Tax (IHT), but is generally exempt from Capital Gains Tax (CGT); the theory being that the same assets cannot be subject to both taxes. The beneficiary is treated as if they acquired the asset at its probate value. This is known as the CGT tax-free uplift on death.
It may be tempting for executors to down-value assets such as property, with a view to reducing the IHT bill, but this will only reduce the base cost of the asset, and potentially increase any CGT liability, so this needs to be considered.
Who should realise the capital gains – the estate or the beneficiaries?
Often the executors will sell some or all the assets, and then distribute the cash to the beneficiaries. In this case it is the executors who make any post-death gains/losses, so they will submit a tax return to HM Revenue & Customs and pay any CGT due.
The executors are able to claim the full annual CGT exemption, currently £12,300 for 2020/21, in the year of death and in the two following tax years. Any chargeable gains are subject to CGT at the higher rate, which is 28% for residential properties and 20% for all other chargeable assets.
However, there can be some tax planning opportunities if assets are handed to beneficiaries before they are sold. The beneficiaries can stagger the sales of assets over different tax years, and possibly claim multiple annual CGT exemptions. They can also utilise any personal capital losses they may have brought forward, and potentially pay tax at a lower rate than the executors, if any of the gains fall within their basic rate band, so they would pay tax at 10/18% instead of 20/28%.
What about the deceased’s CGT position in the year of death?
While CGT liabilities die with you, what about assets that the deceased has already disposed of in the tax year in which they die?
Any capital gains have to be disclosed on the deceased’s tax return for the period from 6 April to the date of their death, and they are entitled to a full annual CGT exemption.
Capital losses in the period to the date of death are automatically offset against any capital gains. Any capital losses brought forward can be offset, as long as any chargeable gains exceed the annual CGT exemption.
Any unused capital losses still remaining can be carried back and offset against any capital gains the deceased may have realised in the three tax years prior to the tax year of death. However the losses must be offset against gains in a later year, before setting them off against gains from an earlier year.