Cash clinic: How do capital gains tax and inheritance tax interact on death?

By LAURA KING
Published on 14/07/2012 13:47

Q: A recent article in Smart Money made me realise that I don’t know how capital gains tax (CGT) and inheritance tax (IHT) interact on death. Is the estate first assessed for CGT based on valuations at the date of death, and then the net value after deduction of the CGT assessed for IHT?

GA Edinburgh

A: When someone dies, the assets they own pass to the person looking after the estate - known as the “executor” or “personal representative”. There is no CGT to pay at that time, even though the assets have changed hands. In effect, the capital gains up to the date of death are wiped out and the executor starts with a clean sheet.

The executors or personal representatives are, however, still responsible for dealing with any CGT due on assets that the person sold or disposed before they died. This is treated as a debt on the estate, reducing the net value on which IHT is calculated.

After a person dies, the personal representatives may sell or pass the assets to the beneficiaries. If the executor sells the asset, they will need to work out the gain or loss on the disposal. This is done by reference to the value on the date of death, not the value when the deceased person acquired it. If the executor passes an asset on to a beneficiary as part of their entitlement, there’s no CGT to pay at that time.

When the beneficiary sells or disposes of an inherited asset, they may be liable to CGT on any profit or gain made. This is calculated by reference to the value at the date of death of the person from whom they inherited it. They will therefore need to get a valuation of the asset at the date of death, and use this value as the “cost” of the asset to work out the gain or loss. If the value has been agreed for IHT purposes they should use the same valuation.

As for IHT on death, there won’t be any due if the whole of the estate is worth less than the IHT threshold (currently £325,000). The personal representatives will usually pay any IHT due from the estate’s assets before passing shares on to the beneficiaries.

If you think your estate will be subject to IHT, you should discuss with an adviser the ways in which you can mitigate this potential liability. One option could be to set up a trust. There could be IHT payable when you set up the trust, but if the amount falls within your available “nil rate band” (£325,000), no tax would be payable. Provided you then survive another seven years, no further tax should be payable on your death.

Remember that a trust would generally have to be set up with a lump sum as instalment payments to trusts can, depending on the circumstances, result in adverse tax consequences.

Transferring assets to a trust also counts as a disposal for CGT and can give rise to a tax liability. In most cases, it is possible to “hold over” the gains, effectively deferring the liability by passing it on to the trust.

• Laura King is a senior solicitor within the private client & financial services department at HBJ Gateley.

If you have a question you need answered, write to Jeff Salway, ℅The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or email: [e-mail]. The above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and HBJ Gateley accept no liability on the basis of this article.