The Inheritance Tax Dilemma
When a beneficiary inherits property in Kenya and later decides to sell it, determining the correct Capital Gains Tax (CGT) liability has been a contentious issue. Should the tax be calculated on the entire sale proceeds, since the beneficiary paid nothing for the property? Or should the property’s value at inheritance serve as the acquisition cost? Recent legal decisions and legislative changes have finally brought clarity to this important area of tax law.
This comprehensive guide examines the current legal framework, analyzes landmark cases, and provides practical advice for beneficiaries, executors, and tax professionals.
Key Statutory Provisions
1. The Foundation: Income Tax Act, Eighth Schedule
Kenya’s CGT regime is governed by the Eighth Schedule of the Income Tax Act, which contains several crucial provisions:
- Paragraph 8: Defines “adjusted cost” as consideration paid plus enhancement costs, title defense expenses, and incidental acquisition costs
- Paragraph 9: Establishes that property acquired “by way of a gift” or “between related persons” is deemed acquired at market value at the time of acquisition
- Paragraph 6(2)(d): Exempts transfers to legatees during estate administration from being treated as taxable transfers
2. Finance Act 2023
The Finance Act 2023 introduced Paragraph 8(4A), creating a five-year anti-avoidance rule:
- If inherited property is sold within five years of acquisition, the cost base reverts to the deceased’s original acquisition cost
- Only after five years can beneficiaries use the rebased market value at inheritance
Landmark Cases: Establishing Legal Precedents
Case 1: Commissioner of Domestic Taxes v. Shah & 2 Others (2023)
The Facts:
- Three siblings inherited property valued at Kshs 389.6 million in 2015
- Sold in 2020 for Kshs 305.6 million
- Claimed capital loss based on inherited value
The Decision: The Tax Appeals Tribunal and High Court established the “rebasing principle”:
- Inherited property is deemed acquired at market value at date of inheritance
- This becomes the cost base for future CGT calculations
- Since sale price was lower than inherited value, no CGT was payable
Significance: First clear judicial affirmation that beneficiaries don’t inherit a “zero” cost base.
Case 2: Dhanjal v Commissioner of Domestic Taxes (2024)
The Facts:
- Property inherited in 2014, valued at Kshs 150 million
- Sold in 2022 for Kshs 177.9 million
- KRA attempted to disallow the Kshs 150 million acquisition cost
The Decision: The Tribunal reinforced the Shah principles and added crucial clarifications:
- Paragraph 6(2)(d) (exempting estate transfers) doesn’t negate that an acquisition occurred
- For stamp-duty-exempt inheritances, market value is the default cost base
- Third-party valuations (like bank-commissioned reports) carry significant weight
Significance: Closed potential loopholes in KRA’s arguments and strengthened the rebasing principle.
Practical Guide for Beneficiaries
Step 1: Upon Inheritance – Document Everything
- Obtain Professional Valuation: Engage a reputable value immediately to document market value at date of death
- Gather Historical Records: Collect deceased’s purchase documents, improvement records, and title documents
- Document Expenses: Record all succession costs, legal fees, and transmission expenses
Step 2: Planning the Sale – Timing is everything
- Understand the 5-Year Cliff: Selling before 5 years triggers significantly higher tax
- Weigh Market Conditions: Balance selling in a strong market against tax savings of waiting
Step 3: Calculating Your Tax Liability
Capital Gain = Sale Price – Adjusted Cost
CGT Payable = Capital Gain × 15%
Adjusted Cost Includes:
1. Deceased’s acquisition cost (if sold within 5 years)
OR
Market value at inheritance (if sold after 5 years)
2. Deceased’s enhancement costs
3. Your post-inheritance improvements
4. Title defense costs
5. Incidental acquisition and sale costs
Common Pitfalls to Avoid
1. The “Zero Cost” Mistake
Assuming your cost base is zero because you paid nothing for the inheritance could lead to massively overtaxing yourself.
2. Ignoring the Five-Year Rule
Many beneficiaries remain unaware of the 2023 change and face unexpected tax bills when selling within five years.
3. Poor Documentation
Without proper records, you cannot substantiate your cost base during a KRA audit.
4. Mixing Personal and Capital Expenses
Only expenses that genuinely enhance or preserve property value qualify – personal expenses don’t count.
Conclusion
The taxation of inherited property sales in Kenya has evolved significantly:
1. The Principle is clear: Inherited property receives a stepped-up cost basis equal to market value at inheritance (Paragraph 9).
2. The Exception is Time-Based: If sold within five years, you must use the deceased’s original cost base (Paragraph 8(4A)).
3. Documentation is Critical: Professional valuations and thorough record-keeping are non-negotiable.
4. Timing Matters Strategically: The five-year threshold represents a significant tax planning consideration.
The Shah and Dhanjal cases have established a predictable framework that balances appropriate taxation with fairness to beneficiaries. By understanding these rules, maintaining meticulous records, and planning strategically, beneficiaries can navigate CGT on inherited property efficiently, ensuring compliance while optimizing their financial outcome.
Understanding Inherited Property Tax Implications