Estate planning – managing your finances so you can pass on as much as you can and want – is often talked about in reference to inheritance tax. But what about capital gains tax?

What is capital gains tax?

Capital gains tax (CGT) is a tax on the profit you make when you sell, give away, swap or are compensated for an asset that has increased in value since the time you purchased.

Importantly, the gain is taxed, not the amount of money you receive on the sale. HMRC gives this example: you buy a painting for £5,000 and sell it later for £25,000. In this case, you’ve made a gain of £20,000, which may face a CGT charge.

There is a tax-free allowance (£3,000) available to everyone. For gains made from 30 October 2024 onwards, you’ll pay:

• 18% if you pay basic rate income tax
• 24% if you pay higher rate income tax.

When it comes to estate planning, inheritance tax is usually paid by the estate of the person who’s died. However, you may still have to deal with CGT if you later dispose of an asset.

How does inheritance affect capital gains tax?

When discussing estate planning, most people tend to focus on inheritance tax (IHT). This is a tax on the value of an individual’s estate above a certain threshold (called the nil-rate band) when they die. Typically, the estate itself is responsible for paying any inheritance tax due, and in many cases, that means there’s no immediate financial burden on the beneficiaries.

However, capital gains tax can come into play when you eventually dispose of any inherited assets. For instance, if you inherit a property or shares and then decide to sell them some time later, you may have to pay CGT on any increase in value since the date of death. In some cases, an estate’s assets may also be sold by the executor or administrator during the process of estate administration. In such scenarios, a potential CGT liability could arise at that stage.

Capital gains tax within an estate

Within an estate, there are different parties involved who might handle or own the assets at any point in the process. These parties include:

1. Personal representatives (executors or administrators)
   The personal representatives are responsible for administering the estate, settling any outstanding debts, and distributing the assets according to the will (or the rules of intestacy if there is no valid will). If they dispose of assets on behalf of the estate – perhaps to raise funds for the estate’s liabilities or to split an indivisible asset among beneficiaries – they may trigger a CGT liability.
2. Beneficiaries
   Beneficiaries receive assets from the estate. A key point is that beneficiaries typically do not have to pay CGT on the mere transfer of an asset from the estate to them, even if it has risen in value since the deceased originally acquired it. However, if they later dispose of the inherited assets and the value has increased since the date of death, they could face a CGT charge.

CGT annual exemption and timelines

Personal representatives can usually claim the full amount of the annual CGT exemption (currently £3,000) during the year of death and the following two tax years, as long as the estate is still under administration. After that period, no further annual exemption is allowed for the estate.

It’s crucial to be aware that any unused portion of that exemption from one year cannot roll over into subsequent tax years. Therefore, timing certain disposals might help personal representatives mitigate unnecessary CGT. For instance, if there is potential for a large gain that could surpass the CGT allowance, it might be beneficial to plan disposals across two or more tax years (if feasible) to maximise the use of the annual exemption.

Estate planning beyond inheritance tax

While inheritance tax is often the main focus of estate planning, ignoring CGT considerations can lead to unexpected liabilities. Here are a few tips to help you plan ahead more effectively:

1. Early planning
   If you anticipate selling or transferring certain assets in the future, it can be beneficial to think carefully about when you do so and how the transaction is structured. If you own highly appreciated assets, spreading disposals across multiple tax years might help make better use of CGT allowances.
2. Consider gifting during your lifetime
   Gifting assets before death can sometimes mitigate a future CGT liability, although you must also be mindful of potential IHT implications, depending on the value of the assets and when the gifts are made. If an asset is likely to appreciate further, gifting sooner might be advantageous. However, any immediate gain above your allowance might still be subject to CGT, so weighing up both sides is crucial.
3. Use of trusts
   Trusts can be a sophisticated tool in estate planning, potentially offering some control over how and when beneficiaries receive assets. Depending on the nature of the trust, there might be CGT and IHT implications – these can be complex and should be carefully planned with professional advice.
4. Keeping clear records
   Maintaining detailed records of how, when, and for how much you acquire or dispose of assets is essential. This includes improvements made to properties, professional fees paid, and other relevant costs. Having accurate records will make it easier to calculate any future CGT bill and also helps personal representatives in the event of your death.
5. Regular reviews
   Estate planning is not just a one-time exercise. It’s important to revisit your plans periodically – especially if your circumstances change (e.g. marriage, divorce, new children or grandchildren, significant increase in asset values). Reviewing your will and estate strategy in the context of current tax legislation helps ensure your wishes are carried out efficiently.

Seek professional advice

Capital gains tax in relation to estate planning can be a complicated affair. While the straightforward cases might be manageable with knowledge of HMRC guidelines, many scenarios can become complex, especially if you’re dealing with trusts, multiple properties, or high-value assets. Tax laws can and do change over time, which makes it all the more important to stay up to date with the latest regulations.

An experienced accountant and business adviser like Smith Butler can guide you through:

• Accurately valuing assets,
• Navigating inheritance tax and CGT rules,
• Ensuring correct use of exemptions and reliefs,
• Managing estate administration within the legal deadlines.

A comprehensive estate plan that accounts for CGT, inheritance tax, and other obligations will help ensure the best outcome for you and your beneficiaries.

Get in touch with us for more advice or personalised assistance.