How to value let property on death

The death of a property investor can create significant problems for those left behind, who have to sort out the deceased’s estate and pay any inheritance tax due.

Probate problem

When a person dies the executors (personal representatives: PRs, if there is no will) have to apply for a grant of probate before the assets can be distributed. Simple estates with few assets can skip the probate stage, but any estate containing let property is likely to need probate and may well have an inheritance tax (IHT) liability.

The first step, as the guide on gov.uk recommends, is to assess where the assets are, and what liabilities there might be. This will involve tracking down what loans are outstanding on the let properties, and determining whether any properties are jointly owned. The executors also need to check what bank accounts exist if there are any overseas assets, other investments, and what gifts the deceased made in the seven years before they died.

Before probate can be granted the executor has to complete a rather daunting HMRC form; either the IHT205 or the more complex IHT400. Low value or exempt estates can complete the IHT205 form if there is no IHT to pay.

‘Low value’ means the gross value of the estate is less than the available nil rate band (currently £325,000). ‘Exempt’ means the gross value of the estate does not exceed £3 million and most of it is left to a spouse or charity, so the net remains below the nil rate band.

So, before the executor can even decide which IHT form to use they need to estimate the gross value of the deceased’s estate. This is not straightforward, as there are special valuation rules for assets that apply for inheritance tax purposes.

Value on death

The overriding rule is that the estate must be valued based on a deemed transfer immediately before the deceased’s death at open market value. In other words, it is necessary to examine the condition of the assets as they existed at the moment of death.

Normally all of the IHT due has to be paid before probate can be granted, so it is important to get the initial valuation of the estate as accurate as possible for IHT purposes.

Tenants in place

Where a let property has a tenant in occupation at the date of death, the value of that property for IHT purposes is the tenanted value. This will be less than the normal sale value, but how much that discount amounts to can be difficult to assess.

When an estate agent is asked to provide a value for a property they will normally assume it is to be sold at some point in the near future with 'vacant possession'. However, when valuing a let property for IHT purposes the valuer must be instructed to take into account how much the property could be sold for with the tenant in residence.

The value for IHT must also factor in the reversionary interest of the lease or licence, considering when the lease will cease, or when next break point is. A property with a lease that has only a short time to run will be worth more than an identical property that is subject to a longer lease.

Joint ownership

Where a property is jointly owned the executors must determine whether it is held as joint tenants (‘joint owners’ in Scotland) who the other owners are. On death, the surviving joint owner will automatically inherit the property. If this is the spouse or civil partner the value of the property for probate is exactly half.

However, if the joint owner or owners are friends or siblings the value for IHT is obtained by:

• dividing the value by the number of owners; and

• deducting 10% from the share of the deceased person

The alternative method of ownership is as tenants in common (‘common owners’ in Scotland). In this case the share of the property owned by the deceased will be the percentage set out in the deed of beneficial interest, so that percentage must be taken into account for IHT purposes.  

Taxes to pay

IHT is payable at 40% of the net estate (after deduction of the nil rate band, exempt gifts and any debts), or at 36% if the reduced rate applies where at least 10% of the net estate has been left to charity.

When IHT has been overpaid on the estimated value of the estate it can be reclaimed, and HMRC will pay interest on the overpaid amount. HMRC may also accept payment of the IHT by instalments where one or more properties have to be sold to pay the tax.  

If the executors or PRs sell a property from the estate at a value in excess of the probate value, that gain is potentially subject to CGT. However, in the tax year of death and the following two years the PRs are entitled deduct from the gain the annual exempt amount (currently £12,300 per year).

The net gain, after deduction of the annual exempt amount, is subject to CGT at 28%, which is considerably less than the IHT payable at 40% or 36%. It may thus make sense to pay IHT on the lower tenanted value of a let property, then later sell the property with vacant possession, paying CGT on any gain.  

Example

Pam died owning a let property worth £200,000, being the tenanted value. Her nil rate band has been set against her primary home. The PRs pay IHT of £80,000 on the probate value of the let property (£200,000 x 40%).

One year after her death the PRs sell the let property with vacant possession for £350,000. The gain arising is subject to CGT at 28%. The PRs must pay CGT on £137,700 (£350,000-200,000–12,300) being £38,556, within 60 days of completion of the sale.  

Advice

Inheritance tax is complex, and the forms are complicated and time-consuming, so it may be worthwhile paying for professional assistance at this difficult time.