What happens when you inherit a house?

For some, it could be the family home they grew up in, which means the property comes with plenty of memories, be they good or bad.

For others, the property may not be one they have grown up in, but in either instance it could be geographically far from where they currently reside.

Inheriting a property comes with lots of decisions that fall to the beneficiary to make, such as whether the property should be kept as a house, a rental home or sold to another owner.

Or maybe, if the property has been left to multiple members of a family, there will be more than one person making the decision and, potentially, the opportunity to share any financial gains.

The condition of the property when it is inherited may help in the decision-making process.

It’s important for those who are expecting to inherit a property to properly understand the tax implications and associated costs involved.Paresh Raja

Research among 2,000 UK adults conducted by bridging lender Market Financial Solutions and published in September last year, revealed 36 per cent were set to inherit a property, which it estimated was equivalent to 18.6m people in the UK.

Its findings coincided with research from Royal London, which estimated that £400bn worth of property will be passed from grandparents to younger generations in the coming decade.

The UK is set to witness a monumental transition of property wealth over the coming decades, according to Paresh Raja, chief executive of Market Financial Solutions.

"Furthermore, the expected value of the property they are due to inherit all or part of comes to an average of £347,500," he points out. "Therefore, it’s important for those who are expecting to inherit a property to properly understand the tax implications and associated costs involved."

Financial advisers should prepare for more questions and queries around property inheritance from clients in the coming years.

First steps

So what happens when someone inherits a property?

To start with, the individual or family members who have unexpectedly taken ownership of the property will have to follow a process and bear in mind any tax that may have to be paid upon receipt of the property.

Tony Mudd, divisional director, tax and technical support at St James’s Place, explains there is a formal administration process to follow upon inheriting a house.

“Practically, this involves probate being granted, with the executors thereafter transferring the property to the beneficiary and lodging the change with the Land Registry. The beneficiary now has the choice to retain and rent, to retain as a second property, or sell,” he says.

He suggests any inheritance tax liability would have been settled by the estate prior to distribution.

But Mr Mudd notes: “In the case that there are evident gains by inheriting the property – for example, the difference between purchase price of the property and its subsequent value at death – they would be wiped out on death. 

“This means that the recipient will inherit the property with a base cost for capital gains tax purposes as the value given at probate. 

“The beneficiary (new owner) will hold responsibility for any additional gains from the date of probate through to the date of any potential sale.”

Complications can arise, depending on whether the beneficiary has been left just with the property or the wider estate.

Philip Hanley, a director and independent financial adviser at Philip James Financial Services, clarifies: “If it's just the house and it's worth more than the IHT nil-rate band, it may have to be sold to pay the tax. 

“If it was their home, and you’re a child or grandchild, the new residential nil-rate band could help by increasing the tax-free amount that can be passed on. And if, for instance, the property was jointly owned by parents or grandparents, the allowance could be doubled.”

Devil in the detail

Inheritance tax (IHT) is likely to be the biggest tax liability a beneficiary will face, warns Lawrence Adair, private client senior manager at HW Fisher & Company, and the one over which they will have least control.

He confirms that, “strictly speaking the tax liability falls on the estate”, so it will generally be paid before any beneficiaries get their hands on it.

But he explains: “Most estates involve a property, which may make it problematic to pay an inheritance tax bill immediately. Those inheriting a property can choose to sell it, and use the proceeds to pay the tax.

“But if they choose to keep the property – either to live in or to let out – they can opt to pay the IHT bill in equal annual instalments. HMRC allows these to be made over 10 years, and currently charges interest of 2.5 per cent on the outstanding amount.”

Mr Adair points out some exemptions which ensure not everyone has to pay IHT.

In the case where no common action can be agreed between family members, you would likely look to sell the property and distribute monies.Tony Mudd

“At present, it is charged on estates worth over £325,000 if the deceased person were single,” he explains. “If the deceased were the second person in a couple to die, that allowance – often called the nil-rate band – may be doubled to £650,000.

“Last year the government introduced an extra exemption for estates, which include a property that has been used by the deceased as a residence. 

“Called the residence nil-rate band, this currently adds up to an additional £125,000 per deceased person onto the allowance where the property is passed to descendants.”

In the case of someone inheriting after the death of their second parent, he notes, the total exemption would be £650,000 plus £250,000, which equals £900,000.

Mr Adair states: “Within the next two years, the government is due to increase the residence nil-rate band, so that by 2020 the total nil-rate band could be £1m, which will benefit those living in southern England where property values have climbed highest.”

Possible complications

What if the property in question is bestowed to more than one family member? Are there further complications in this instance?

“The main consideration here is the nature of the asset itself, namely that property is illiquid,” Mr Mudd points out. 

“Family members may therefore hold different requirements about how it should be managed; should the property be sold? Would it be a better long-term option to rent it out, or is it best to retain it?” 

Mr Hanley adds: “If it's left to you and, for instance, your brother(s) and sister(s), you'll have to decide what to do with it.”

It could be that there is no agreement among all parties about the inherited property.

“If you all agree to keep it, fine. If not, it may have to be sold anyway, unless the one who wants to keep it can afford to buy out the others,” Mr Hanley says.

“In the case where no common action can be agreed between family members, you would likely look to sell the property and distribute the money, or one party will have to raise funds to purchase the interest of the other family member not wishing to retain the property,” Mr Mudd advises.

“Other complexities related to this can arise around appropriate valuations of the property and a sharing of any costs associated with the transaction – legal costs, advice costs and finance.”

eleanor.duncan@ft.com