Capital Gains Tax vs. Income Tax on Rental Income: Essential Information for Landlords

Inheriting a buy-to-let property can be both a financial boon and a complex tax situation. When selling such a property, understanding Capital Gains Tax (CGT) is crucial to avoiding unexpected liabilities. If you sell an inherited buy-to-let property at a profit, you will be liable to pay Capital Gains Tax on any amount exceeding the property’s value at the time it was inherited.

Capital Gains Tax on buy-to-let properties in the UK depends largely on your income tax bracket. Basic rate taxpayers in 2024/25 may pay a different CGT rate compared to those in higher tax categories. Knowing these rates and thresholds is vital for accurate tax planning and compliance. Additionally, various allowances and deductions can impact the amount of tax owed, making it imperative to calculate correctly.

Strategically managing inherited properties can offer significant financial advantages. Estate planning can help reduce liabilities and ensure compliance with tax regulations. Being well-informed about the nuances of Capital Gains Tax can result in better financial outcomes and fewer surprises.

Key Takeaways

  • Understand CGT obligations when selling inherited buy-to-let properties.
  • Tax rates depend on your overall income and specific tax bracket.
  • Strategic planning can minimise tax liabilities and maximise financial benefits.

Understanding Capital Gains Tax

Capital Gains Tax (CGT) is a tax on the profit made from selling an asset that’s increased in value. It is crucial to understand how it works, especially when the asset in question is an inherited buy-to-let property.

Definition and Overview of Capital Gains Tax (CGT)

Capital Gains Tax is levied on the profit made when an asset is sold for more than its purchase price. The tax applies to various assets including property, stocks, and valuable items. Only the gain is taxed, not the total sale price. For example, if one sells a property for £300,000 that was originally purchased for £200,000, CGT is applied to the £100,000 gain.

There are different rates for CGT depending on the type of asset and the individual’s income tax band. For residential property, higher-rate taxpayers typically face a 28% CGT rate, while basic-rate taxpayers might pay between 18% and 28%, depending on their other taxable income.

How CGT Applies to Inherited Buy-to-Let Properties

When inheriting a buy-to-let property, CGT becomes relevant if the property is sold. The gain is calculated from the property’s value at the time of inheritance, not its original purchase price. For instance, if an individual inherits a property valued at £250,000 and later sells it for £300,000, the CGT is calculated on the £50,000 gain.

Inheritance Tax may also apply when the estate exceeds a certain threshold. However, CGT is distinct from Inheritance Tax and is only concerned with the profit made after the property is inherited. The tax rate applied depends on the individual’s income tax bracket during the tax year the property is sold.

Calculating CGT for Inherited Properties

To calculate CGT on an inherited property, identify the property’s market value at the time of inheritance. Subtract this value from the selling price to determine the gain. Next, deduct allowable expenses such as legal fees, estate agent fees, and any capital improvements made to the property.

For example, if a property was worth £250,000 at inheritance and sold for £300,000, with £10,000 in allowable expenses, the taxable gain is £40,000. Depending on the taxpayer’s income tax bracket, the applicable CGT rate (18% or 28%) is applied to this gain.

Using relevant GOV.UK resources can provide specific details and calculators to help individuals determine their specific tax obligations efficiently.

Determining the Taxable Gain

Calculating the taxable gain on an inherited buy-to-let property involves determining its market value, accounting for deductible costs, and utilising various tax allowances and reliefs. These steps are essential to accurately establish how much tax needs to be paid.

Establishing the Market Value

The first step in determining the taxable gain is to establish the market value of the property at the time of inheritance. This value serves as the base cost for calculating the gain.

To find this value, an estate agent can provide an accurate market valuation. Alternatively, one can use a professional valuer. This valuation is crucial because the property’s future sale price will be compared against it to calculate the profit.

Deductible Costs and Expenses

Several costs and expenses are deductible when calculating the taxable gain. These expenses can significantly reduce the amount of tax owed. Examples include estate agent fees, solicitors’ fees, and maintenance costs made to enhance the property’s value.

Additionally, any costs incurred during the selling process, such as legal fees and commissions paid to the estate agent, are deductible. These deductions ensure that the taxable gain reflects the true profit from the sale.

Utilising Allowances and Reliefs

Maximising available allowances and tax reliefs is key to reducing the taxable gain. The annual Capital Gains Tax allowance is one such method. For the 2023-2024 tax year, this allowance stands at £6,000.

Reliefs like Private Residence Relief might apply if the property was at any time your main home. Letting relief might also be available, reducing the tax liability further if the property was let out before being sold. These reliefs play a significant role in minimising the final amount of tax to be paid.

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Tax Implications and Liabilities

When inheriting buy-to-let properties, understanding the specific tax implications is essential. Key aspects include the rates and payment of Capital Gains Tax (CGT) and the process for reporting and paying CGT.

Rates and Payment of CGT

Capital Gains Tax is payable on the profit made from selling an inherited property. The amount of CGT depends on the property’s increase in value from the date of inheritance to the date of sale. For basic-rate taxpayers, the CGT rate is 18% on gains from residential property. Higher rate and additional rate taxpayers face a higher CGT rate of 28% on their total taxable profit.

If the property is sold within the basic rate band, it might qualify for the lower tax rate. HMRC requires payment of CGT within a specific timeframe, typically by 31 January following the end of the tax year in which the property was sold. Timely payment is crucial to avoid penalties and interest.

Reporting and Paying CGT

Reporting CGT involves completing a self-assessment tax return. Individuals must declare the sale of the inherited property and any resulting profit. Accurate reporting ensures compliance with HMRC regulations. For those within the UK property market, the self-assessment process can be straightforward but requires attention to detail.

Payments can be made via the self-assessment system. It’s critical to keep records of property valuation at inheritance and sale, as these figures determine tax liability. For individuals selling inherited property via a limited company, different rules may apply, requiring professional advice to navigate tax regulations effectively.

For more information on CGT rates and payment processes, visit the Capital Gains Tax on Inherited Property page.

Strategic Estate Planning

Strategic estate planning for inherited buy-to-let properties involves efficient tax mitigation and ensuring that assets are passed smoothly to the next generation. This often includes transferring properties between spouses or civil partners and considering future sales or gifts to reduce the tax burden.

Transfer between Spouses and Civil Partners

When it comes to estate planning, a significant strategy involves transferring inherited buy-to-let properties between spouses or civil partners. Such transfers are usually exempt from Capital Gains Tax (CGT) and Inheritance Tax (IHT). This transfer avoids immediate tax liabilities and can be part of a broader estate restructuring plan.

Spouses and civil partners can jointly own the inherited property, optimising income tax allowances and tax brackets. By doing so, the couple could potentially benefit from both personal allowances and reduce their overall tax bill. The property’s income can be split equally, ensuring each partner utilises their full tax allowances.

Utilising this strategy also ensures that the property remains within the family unit, providing financial stability and continuity. If the inherited property continues to generate rental income, the couple can effectively manage it under shared ownership.

Considerations for Future Sales or Gifts

Many individuals consider future sales or gifts as part of their estate planning. Gifting buy-to-let properties can initiate the seven-year rule for IHT purposes, potentially reducing the estate’s taxable value if the donor survives seven years post-gift.

However, such a gift is treated as a disposal event for CGT calculations. The property’s capital gain, calculated from the acquisition to the gift date, may incur an 18% or 28% tax rate. Hence, it is crucial to assess the property’s gain and plan for the tax implication.

Selling inherited properties before significant capital appreciation can also be a strategic move. It ensures that the CGT liability is manageable. Setting up a company or trust to manage these properties can diversify the ownership and control of the estate, facilitating smoother transitions and tax planning.

Frequently Asked Questions

When dealing with capital gains tax (CGT) on inherited buy-to-let properties, several complex situations may arise. These questions address calculation methods, implications for joint ownership, tax liabilities, and potential strategies to minimise CGT.

How can capital gains tax on an inherited buy-to-let property be calculated?

To calculate CGT on an inherited property, determine the property’s market value at the time of inheritance, then deduct this from the sale price. The gain is subject to CGT rates depending on whether you are a basic or higher-rate taxpayer. Standard CGT rates apply as detailed in relevant HMRC guidelines.

What are the capital gains tax implications for jointly owned inherited properties?

For jointly owned properties, each owner is liable for CGT on their share of the gain. This means calculating each person’s gain based on their ownership percentage. Each owner can also apply their CGT allowance individually, which can sometimes result in significant tax savings.

Is capital gains tax due on a house that has been fully paid off and then inherited?

If a fully paid-off house is inherited and then sold, CGT is still applicable. The tax is calculated based on the gain from the property’s market value at the time of inheritance to the sale price. The status of the property’s mortgage does not affect CGT liability.

How might one legally minimise capital gains tax liability on an inherited rental property?

One strategy to legally minimise CGT liability is to use the annual CGT allowance. Additionally, making the property your main residence for a period or gifting portions to lower-rate taxpayers within the family can reduce overall tax. Consulting with a tax advisor for tailored advice is advisable.

What is the time frame in which one must reside in an inherited property to be exempt from capital gains tax?

To potentially qualify for Private Residence Relief, which can exempt you from CGT, you must live in the inherited property as your main residence. While the exact duration varies, typically at least one to two years of genuine residence is required to be eligible for this relief.

Does inheriting a buy-to-let property result in both capital gains and inheritance tax liabilities?

Inheriting a buy-to-let property can result in both CGT and inheritance tax liabilities. Inheritance tax is assessed on the deceased’s estate at the time of death, potentially applying to the property’s value. CGT is calculated on the gain upon subsequent sale of the property. More details can be found from official guidelines.

Need help with tax or accounting on a rental property? Reach out to Wimbledon’s top rated accounts Cigma Accounting today.

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