Inherited Property and Capital Gains Tax in Kenya: How the Five-Year Rule Can Save You Millions

A parent can leave you land worth millions. But if you decide to sell that land, the exact date you sell it makes a significant difference to your Capital Gains Tax bill.

The old Holy Bible says in Proverbs 13:22:

• “A good man leaves an inheritance for his children's children.”

For many Kenyan families, that inheritance is land, a family home, commercial property, or shares in a company. A parent may have bought these assets decades ago for a fraction of what they are worth today.

When the parent dies and the property is transferred to the children, or transfers the property to the children while still alive, that transfer is exempt from Capital Gains Tax (CGT). Zero CGT is paid to KRA.

But what happens when the child decides to sell the inherited property to a third party?

This is where the tax question becomes interesting.

Does KRA calculate the gain using the price the deceased parent originally paid for the property? Or can the child use the property's market value at the time of inheritance?

The answer depends on the five year rule set in the Kenya's Income Tax Act.

But first things first.

What is Capital Gains Tax?

What is the cost of inherited property when you sell it?

The challenge with inherited property is determining the acquisition cost.

Imagine that your parent bought land for KSh 1 million in 2002. You inherit it when its market price is KSh 8 million and later sell it for KSh 10 million.

Should your acquisition cost be KSh 1 million or KSh 8 million?

The answer matters because the two figures produce very different tax bills.

If the cost is KSh 1 million, the gain is KSh 9 million.

If the cost is KSh 8 million, the gain is KSh 2 million.

That is a difference of KSh 7 million in the gain used to calculate CGT.

The Eighth Schedule addresses this issue through two provisions that must be read together: Paragraph 8(4A), which contains the five-year rule, and Paragraph 9, which provides rules for determining market value in certain transactions, including transfers by way of a gift and transfers between related persons.

What is the five year CGT rule?

Paragraph 8(4A) of the Eighth Schedule to the Income Tax Act provides, and I quote:

“Where property is transferred in a transaction that is not subject to capital gains tax, and the property is subsequently transferred in a taxable transaction within a period of less than five years, then the adjusted cost in the subsequent transfer shall be based on the original adjusted cost as determined in the first transfer.”

In practical terms, the rule prevents a person from automatically using a new market-value cost basis when property is transferred through a transaction that is not subject to CGT and then sold in a taxable transaction within five years.

For inherited property, this means the beneficiary must use the parent's original purchase cost when selling the property before the end of the five years.

If the property is sold after five years, Paragraph 8(4A)'s carryover restriction no longer applies on that basis. The market-value rules under Paragraph 9 then determine the acquisition cost used in calculating the gain.

Let's see how this works with an example.

Worked example: Selling inherited land within five years

Suppose,

• Your father bought land in 2002 for KSh 1,000,000.

• You inherited the land in 2020.

• The land's market value at the time of inheritance was KSh 8,000,000.

• You sold the land in 2023 for KSh 10,000,000.

You sold the property three years after inheriting it.

Because the sale took place within five years of a transfer that was not subject to CGT, Paragraph 8(4A) applies.

Your cost is based on your father's original cost. Not the KSh 8 million market value at inheritance.

Assuming the original adjusted cost was KSh 1 million and there are no other allowable costs or adjustments:

Sale price is KSh 10,000,000 less Original cost of KSh 1,000,000 
Capital gain = KSh 9,000,000 
CGT at 15% = KSh 1,350,000

Your CGT bill is KSh 1,350,000.

Notice what has happened. Although the land was worth KSh 8 million when you inherited it, the five-year rule requires the original parent's cost to be used for this calculation.

Worked example: Selling the same land after five years

Now change just one fact.

You inherited the land in 2020, but instead of selling it in 2023, you sold it in 2026.

The other figures remain unchanged.

You have now held the inherited property for more than five years.

Paragraph 8(4A) applies where the subsequent taxable transfer occurs within a period of less than five years. It therefore no longer applies on a sale after five years.

Paragraph 9 steps in to determine the acquisition cost. The market value at the time you acquired the property is used as the deemed consideration for the acquisition.

Assuming the KSh 8 million market value at inheritance is the appropriate statutory acquisition cost, and there are no other allowable costs or adjustments:

Sale price is KSh 10,000,000 less Market value at inheritance of KSh 8,000,000 
Capital gain KSh 2,000,000 
CGT at 15% KSh 300,000

Your CGT bill is KSh 300,000.

Compare the two outcomes. The difference in the CGT bill is KSh 1,050,000.

That is why the five-year rule deserves attention before you put inherited property on the market.

What should you do when you inherit property?

If you inherit land, a house, or other property that you may sell in future, take the following practical steps.

First, establish the date of inheritance. Keep the succession documents, confirmed grant, transfer records, and title documents showing when the property was transferred to you.

Second, obtain evidence of the market value at inheritance. An independent valuation prepared by a qualified valuer is important evidence when determining the appropriate acquisition cost under Paragraph 9. Do not wait until you want to sell the property years later to look for this evidence. Keep the valuation report as supporting evidence, as KRA always request it

Third, establish the parent's original adjusted cost. Keep the original purchase agreement, transfer documents, evidence of acquisition expenses, and records of qualifying improvements or other allowable costs. The relevant figure may be more than the original purchase price.

Fourth, calculate the five-year period before agreeing to sell. If the sale will occur within five years of inheriting, the original adjusted cost carryover rule must be considered. A proposed sale date can have a substantial effect on the tax calculation.

Fifth, calculate the tax before completing the sale. Include allowable costs and applicable adjustments, confirm whether any exemption applies, and establish the correct CGT treatment for your circumstances.

Finally, seek a tax accountant to prepare and file the CGT return. And to represent you before KRA during the review of the return and verification of your records by KRA.

In conclusion

As you can see, the practical implication is significant. Two people selling similar inherited properties at the same price may have very different CGT bills depending on the property's cost history, the date of inheritance, the date of sale, and the applicable statutory provisions.

Before and after selling inherited property, establish the correct cost basis and calculate the likely CGT bill.

A little tax planning before the sale can make a substantial difference to what you ultimately pay.

How can ClearTax Help you?

We help property owners understand their CGT obligations, determine the right acquisition cost, identify deductible expenses, calculate and file CGT, represent you before KRA, and represent you before the tax appeal tribunal should KRA become difficult.

Let us help you assess the tax implications.

Book an Online Consultation Now

Written by CPA Joseph Wachira 
Senior tax consultant at ClearTax, specialising in real estate tax advisory and tax dispute resolution.