Articles

Capital Gains Tax on Inherited Property in Kenya

In Kenya, the sale of inherited property can have significant tax implications, particularly concerning Capital Gains Tax (CGT). This article provides a comprehensive guide to how CGT applies when a beneficiary sells inherited property to a third party, the applicable cost of acquisition, key legal precedents, and recent legislative changes that affect such transactions.

What is Capital Gains Tax?

Under the Income Tax Act, Cap 470, Laws of Kenya (ITA), income derived from the transfer of property—such as land, buildings, or shares—is subject to income tax. When property is held for investment purposes, any gain from its sale is classified as a capital gain and is subject to CGT at a rate of 15%. The taxable gain is calculated as the excess of the property’s transfer value (sale price) over its cost of acquisition.

The ITA defines a “transfer” broadly to include scenarios where property is:

  • Sold, exchanged, or conveyed.

  • Disposed of in any manner, including by way of a gift, whether or not for consideration.

Thus, even gifting property can trigger CGT, although specific exemptions exist to mitigate tax liabilities in certain cases.

Exemptions from Capital Gains Tax

The ITA provides several exemptions from CGT, particularly for transactions related to inherited property. These include:

  1. Property transferred or sold for estate administration: If the transfer or sale occurs within two years of the deceased’s death, it is exempt from CGT.

  2. Vesting of property in personal representatives: Property that vests in the personal representatives of a deceased person by operation of law is exempt.

  3. Transfers to legatees during estate administration: Transfers from personal representatives to legatees (beneficiaries) as part of administering the deceased’s estate are also exempt.

These exemptions ensure that the initial transfer of inherited property to beneficiaries does not incur CGT. However, challenges arise when a beneficiary later sells the inherited property to a third party, as the calculation of the taxable gain becomes critical.

Calculating CGT on the Sale of Inherited Property

When a beneficiary sells inherited property to an independent third party, the CGT is calculated as follows:

Gain = Transfer Value (Sale Price) – Acquisition Cost

The key question is: What is the acquisition cost for a property that was inherited, typically without monetary consideration? Two schools of thought have emerged on this issue:

School of Thought 1: Entire Sale Proceeds as the Gain

This perspective argues that since the beneficiary did not incur any monetary cost to acquire the inherited property, the entire sale proceeds should be treated as the taxable gain. In this view, the acquisition cost is effectively zero, resulting in a higher CGT liability.

School of Thought 2: Market Value at the Time of Inheritance

The alternative view posits that the property’s value is rebased upon inheritance. The acquisition cost for any subsequent sale is the market value of the property at the time it was inherited. This approach typically results in a lower taxable gain, as the market value at inheritance serves as the baseline for calculating the gain.

Legal Precedent: The Shah Case

A landmark case, decided by the Tax Appeals Tribunal on March 17, 2023, and upheld by the High Court on June 24, 2024, resolved this debate in favor of the second school of thought. The case involved three siblings who inherited two parcels of land, which were independently valued by Knight Frank in 2015 at a total market value of Kshs. 389,619,600. In 2020, the siblings sold the properties to Risun Development Company for Kshs. 305,584,000.

  • Kenya Revenue Authority (KRA) Argument: The KRA contended that since the siblings inherited the property without incurring a purchase cost, the entire sale amount of Kshs. 305,584,000 should be subject to CGT. The KRA disregarded the market value at the time of inheritance, asserting that the exempt nature of the initial transfer justified taxing the full sale proceeds.

  • Appellants’ Argument: The siblings argued that the acquisition cost should be the market value at the time of inheritance (Kshs. 389,619,600). Since the sale price was lower than this value, they claimed a loss of Kshs. 99,485,087, which exempted them from CGT under tax laws.

Tribunal’s Ruling

The Tribunal relied on Paragraph 9 of the Eighth Schedule to the ITA, which addresses scenarios where property is acquired or transferred:

  • Otherwise than by way of a bargain made at arm’s length.

  • By way of a gift, in whole or in part.

  • For a consideration that cannot be valued.

  • As a result of a transaction between related persons.

In such cases, the consideration for the transfer or acquisition is deemed to be the market value of the property at the time of the transfer or the amount used to compute stamp duty, whichever is lower.

The Tribunal ruled that the property’s value is automatically rebased to the market value at the date of inheritance. Consequently, when the inherited property is sold to a third party, the CGT is calculated based on the difference between the sale price and the rebased market value. In this case, the siblings were justified in using the 2015 Knight Frank valuation as the acquisition cost, resulting in no taxable gain due to the reported loss.

This precedent clarifies that for CGT purposes, the acquisition cost of inherited property is the market value at the time of inheritance. This rebasing mechanism ensures that beneficiaries are not unfairly taxed on the full sale proceeds, particularly when the property’s value may have appreciated significantly before inheritance.

Anti-Avoidance Provisions: The Finance Act 2023

To address potential tax avoidance, the Finance Act 2023 introduced Paragraph 4A to the Eighth Schedule of the ITA. This anti-avoidance provision stipulates that if property is transferred in a transaction exempt from CGT (e.g., inheritance) and is subsequently sold in a taxable transaction within five years, the adjusted cost for the subsequent sale must be based on the original adjusted cost from the first transfer, not the rebased market value.

Impact of the Five-Year Rule

This provision means that beneficiaries who sell inherited property within five years of inheritance cannot benefit from the rebased market value for CGT calculations. Instead, the original cost basis (often lower, as determined at the time of the deceased’s acquisition) is used, potentially increasing the taxable gain. After the five-year period, the rebased market value can be used, aligning with the precedent set in the Shah case.

Example Scenario

Suppose a beneficiary inherits a property in 2024 with a market value of Kshs. 50 million, but the deceased had originally purchased it for Kshs. 10 million. If the beneficiary sells the property in 2026 (within five years) for Kshs. 60 million:

  • Under Paragraph 4A: The adjusted cost is Kshs. 10 million (original cost), resulting in a taxable gain of Kshs. 50 million (60M – 10M).

  • After Five Years: The adjusted cost is Kshs. 50 million (market value at inheritance), resulting in a taxable gain of Kshs. 10 million (60M – 50M).

This rule underscores the importance of timing when planning the sale of inherited property.

Practical Considerations for Beneficiaries

For individuals inheriting property in Kenya, the following steps can help manage CGT liabilities:

  1. Obtain a Professional Valuation: At the time of inheritance, engage a reputable valuer to determine the market value of the property. This valuation will serve as the acquisition cost for future CGT calculations (subject to the five-year rule).

  2. Understand the Timing of Sales: If you plan to sell the property, consider the five-year anti-avoidance period. Waiting beyond five years may reduce your CGT liability by allowing the use of the rebased market value.

  3. Document Transactions: Maintain records of valuations, inheritance documents, and sale agreements to substantiate your CGT calculations in case of a KRA assessment.

  4. Seek Tax Advice: Consult tax professionals to analyze the tax implications of selling inherited property and to explore tax-efficient strategies.

How Tax Advisory Services Can Help

Navigating the complexities of CGT on inherited property requires specialized expertise. Tax advisory services can assist by:

  • Minimizing Tax Liabilities: Identifying exemptions and structuring transactions to reduce CGT exposure.

  • Maximizing Tax Savings: Advising on timing and valuation strategies to optimize the adjusted cost basis.

  • Ensuring Compliance: Managing tax filings and responding to KRA assessments to avoid penalties.

  • Analyzing Transaction Costs: Evaluating the tax implications of property sales to ensure pricing reflects future tax obligations.

By leveraging professional tax advice, beneficiaries can make informed decisions that align with their financial and commercial objectives.

Conclusion

The application of Capital Gains Tax to inherited property in Kenya hinges on the correct determination of the acquisition cost. The precedent set by the Shah case confirms that the market value at the time of inheritance serves as the acquisition cost for CGT purposes, provided the sale occurs after the five-year anti-avoidance period introduced by the Finance Act 2023. Beneficiaries must carefully plan the timing of property sales and seek professional valuations to ensure compliance and minimize tax liabilities. With the right strategies and expert guidance, individuals can navigate the complexities of CGT and achieve their financial goals.