Interaction of CGT and IHT

Although perhaps not the most exciting of topics, a discussion of the two main UK ‘wealth’ taxes, capital gains tax (CGT) and inheritance tax (IHT), is pertinent as it looks inevitable that CGT will be targeted soon by a government trying to reduce the post COVID budget deficit, with IHT potentially also in the Chancellor’s sights.

Although Boris Johnson has said he is ruling out a one-off wealth tax, he, and his Chancellor Rishi Sunak, can be expected to do their best to ‘up’ the tax take from the existing wealth taxes. 

The purpose of this article is to address the interaction between IHT and CGT as this is not always commonly understood.

IHT is currently 40% and the highest rate of CGT, on property, is 28%, falling to 20% on shares and other assets.

If you die in possession of an asset that has a large gain (lets imagine you have a share portfolio which cost £100,000 and is worth £500,000) you don’t pay CGT on death. You ‘just’ pay IHT. HMRC, in their kindness, will only tax you once. So, on the assumption your estate was large enough to ensure that you had no IHT nil rate band available to offset against the value of your share portfolio, your heirs would inherit 60% of £500,000, so £300,000.

However, if you had sold your share portfolio a few years before your death, you would have paid tax at 20% on the gain of £400,000, which is £80,000, leaving you with net proceeds of £420,000. On death, assuming you hadn’t spent or gifted away the money, your estate would suffer a further 40% tax, leaving your heirs with £252,000.

If (or rather when) CGT rates increase in the near future, then this will mean that it makes even less sense for anyone who doesn’t have a decent life expectancy to crystallise gains towards the end of their life. If the top rate of CGT were to increase to 40%, which many commentators see as a likely outcome, the heirs in the above example would have inherited only £204,000 if the owner sold the shares a few years before death and died in possession of the proceeds.

If IHT were to increase too, then things would look even more painful.

So if anyone is giving thought to IHT planning and will need to sell or gift assets that are pregnant with gains as part of their strategy, they should think fast about realising the gains now, to avoid the likely increase in CGT and then immediately give away the proceeds in the hope of surviving the 7 year IHT clock.

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