What Property Owners Must Do to Avoid Costly Tax Mistakes

By  , Accountant, Tax Consultant & Business Advisor

Imagine you inherit a piece of land from your parent. You did not pay a shilling for it, and years later, you decide to sell.

The buyer offers Ksh 12 million. You are happy, but then you remember Capital Gains Tax. The question haunts you: will KRA tax you on the entire Ksh 12 million because you paid nothing? Or can you deduct something as your cost?

For a long time, even tax professionals disagreed. But two landmark court cases and a new law have finally given us a clear answer.

The Shah Case and the Birth of the Rebasing Principle

Let us look at the first landmark case. In 2015, three siblings inherited two parcels of land from their deceased father.

At the time of inheritance, they engaged Knight Frank, an independent valuer, who determined the total market value of the properties to be Ksh 389,619,600. Five years later, in 2020, they sold the properties to a development company for a total of Ksh 305,584,000.

Based on the inherited value and various adjusted costs, they declared a loss of Kshs 99,485,087 and therefore no chargeable gain.

The Kenya Revenue Authority disagreed. KRA issued an assessment notice demanding CGT of Kshs 27,728,475, arguing that since the siblings had paid nothing for the property, their acquisition cost was effectively zero.

The matter went all the way to the Tax Appeals Tribunal and then to the High Court. The Tribunal examined Paragraph 9 of the Eighth Schedule to the Income Tax Act, which provides that where property is acquired otherwise than by way of an arm’s length bargain, the transfer is deemed to have taken place at the open market value of the property at the time of acquisition.

The Tribunal found that KRA was erroneous in disallowing the siblings’ acquisition costs and allowed their appeal. KRA appealed to the High Court, but on 24th June 2024, the High Court upheld the Tribunal’s ruling, establishing a binding precedent.

The Shah case established the “rebasing principle” – when you inherit property, your cost base is the market value at the date of inheritance, not zero. Since the siblings sold for less than that inherited value, they owed no CGT whatsoever.

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The Dhanjal Case Reinforces the Position

Now, let us turn to the second landmark case, which reinforced and expanded the rebasing principle. In 2014, Daljit Singh Dhanjal inherited a piece of land from his father.

He obtained a valuation from a real estate company, which pegged the value of the land at Ksh 150,000,000 at the time of inheritance.

In 2022, he sold the land for Ksh 77,915,900. Dhanjal filed his CGT return, claiming an acquisition cost of Kshs 150,000,000 and incidental costs of Ksh 6,913,814, leaving a gain of approximately Ksh 21,000,000. KRA, however, disallowed the Ksh 150,000,000 acquisition cost, arguing that because Dhanjal inherited the land, he did not actually pay anything to acquire it.

This meant Dhanjal would have to pay tax on the entire sale proceeds, a vastly larger amount.

He objected and took the case to the Tax Appeals Tribunal. The Tribunal examined Paragraph 6(2)(d) of the Income Tax Act, which exempts transfers to legatees during estate administration from CGT.

KRA argued that this exemption meant no acquisition had occurred at all. The Tribunal disagreed. It held that the exemption from CGT upon inheritance does not negate the fact that an acquisition took place. For stamp-duty-exempt inheritances, the market value at inheritance remains the default cost base.

The Tribunal also gave significant weight to the valuation report from the real estate company, noting that third-party valuations carry substantial evidentiary weight. The Tribunal allowed Dhanjal’s appeal, confirming that he was entitled to use the Ksh150,000,000 market value as his acquisition cost.

The Finance Act 2023 and the Five-Year Rule

But just when it seemed the law was settled, Parliament added an important twist. The Finance Act 2023 introduced Paragraph 4A into the Eighth Schedule of the Income Tax Act, creating a five-year anti-avoidance rule.

The provision applies where property is transferred in a transaction not subject to CGT – such as inheritance – and that same property is subsequently transferred in a taxable transaction within a period of less than five years.

In such circumstances, the law provides that the adjusted cost of the property shall be the original adjusted cost in the hands of the previous owner, rather than the market value at the time of inheritance.

In simple terms, if you sell inherited property within five years of inheriting it, you step into the shoes of the deceased and must use whatever they originally paid for the property. If you sell after five years, you get to use the rebased market value at inheritance.

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Let me illustrate with a simple example to make this crystal clear. Suppose a father acquired a property in 1995 at a cost of Kshs 2 million. Upon his death in 2024, the property had a market value of Kshs 20 million and is transmitted to his son. If the son sells the property in 2026 – within five years of inheritance – CGT will be computed using the father’s original acquisition cost of Kshs 2 million. If the son sells the property in 2030 – after five years – CGT will be computed using the rebased market value of Kshs 20 million. The difference in tax liability between these two scenarios can be substantial, particularly where property was acquired decades earlier at very low historical values.

This five-year rule is clearly aimed at preventing tax avoidance. Without it, a person could transfer property to a relative shortly before death or as a gift, and the beneficiary could immediately sell it using a stepped-up cost base equal to the current market value, thereby wiping out any taxable gain.

Parliament closed that loophole by requiring a genuine five-year holding period before the rebasing benefit becomes available.

What This Means for Property Owners and Beneficiaries

So what does this mean for you if you have inherited property? The lesson is straightforward.

First, get a professional valuation immediately upon inheritance, and keep that report forever. That valuation becomes your future cost base if you sell after five years. Second, if possible, wait at least five years before selling. The tax savings can be enormous, especially if the deceased bought the property many decades ago at a very low price.

Third, keep every receipt – succession costs, legal fees, transmission expenses, and any post-inheritance improvements – because all of these can be added to your adjusted cost, reducing your taxable gain. Fourth, never assume your cost is zero. That mistake has cost many people unnecessary tax and penalties.

There is another important point that many beneficiaries overlook. The CGT filing deadline is strict. You must file your return and pay the tax within 30 days of transferring the property. Late payment attracts a penalty of 20% of the tax due, plus interest of 1% per month on the unpaid amount. These penalties can add up quickly and turn a manageable tax bill into a financial headache.

Do not wait until the last minute. Engage a tax professional early, calculate your gain properly, and ensure you meet the deadline.

Finally, remember that the legal framework is now settled. The Shah case established the rebasing principle. The Dhanjal case reinforced it and clarified the weight of third-party valuations. And the Finance Act 2023 introduced the five-year rule to prevent abuse.

These three developments work together to create a system that is fair to beneficiaries while protecting the tax base. If you have inherited property and are thinking of selling, take time to understand these rules. Consult a qualified tax professional who can help you calculate your true gain and file your CGT return correctly. A little planning today can save you millions tomorrow.

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Kenyans receiving services at the Kenya Revenue Authority headquarters. PHOTO/KRA.