Administration of estates - Sale of assets to pay debts, tax...

Learning Outcomes

This article outlines the administration of estates where assets must be sold to fund debts, taxes, and expenses for SQE1 purposes, including:

• identifying and applying the statutory order for paying debts, taxes, expenses, pecuniary legacies, and residue
• distinguishing the duties and powers of personal representatives when deciding which assets to sell, retain, or appropriate
• evaluating how Inheritance Tax, Capital Gains Tax, and Income Tax interact with asset sales and influence timing and choice of realisations
• analysing how secured debts are allocated between charged assets and residue, and when contrary intention or express “free of mortgage” wording shifts the burden
• applying the doctrine of marshalling to adjust entitlements between competing beneficiaries without affecting creditors
• contrasting the treatment of solvent and insolvent estates, including abatement, priorities between unsecured creditors, and avoidance of preferences
• assessing the legal protection afforded to purchasers from personal representatives and the practical requirements for overreaching and valid receipt of sale proceeds
• spotting common pitfalls and typical SQE1-style traps in estate administration scenarios, such as premature distribution, failure to reserve for tax, or sale of specifically gifted assets contrary to the statutory order.

SQE1 Syllabus

For SQE1, you are required to understand the administration of estates from a practical viewpoint, specifically the rules and procedures for selling assets to pay debts, taxes, and expenses, and the responsibilities of personal representatives, with a focus on the following syllabus points:

• The statutory order for payment of debts, taxes, and expenses in estate administration
• Secured debts and contrary intention in the will (free of mortgage; “subject to”/“after” debts)
• The doctrine of marshalling and its impact between beneficiaries
• The powers and duties of personal representatives when selling estate assets
• Appropriation to satisfy legacies and prudent asset selection for sale
• The legal protection for purchasers from personal representatives (joining for transfers; valid receipts)
• The interaction between asset liquidation and tax liabilities (Inheritance Tax, Capital Gains Tax, Income Tax)
• Solvent versus insolvent estates: correct order of payment and protection from personal liability
• The consequences of failing to follow the correct order or breaching fiduciary duties
• Protective steps before distribution (statutory advertisements; timing of financial provision claims)

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the statutory order of application of estate assets to pay debts and legacies?
2. Can a personal representative sell a specifically bequeathed asset to pay debts if there are insufficient liquid assets?
3. What legal protection does a purchaser have when buying estate property from a personal representative?
4. How does the sale of estate assets affect Inheritance Tax and Capital Gains Tax liabilities?

Introduction

When administering an estate, personal representatives (PRs) must ensure that all debts, taxes, and expenses are paid before distributing assets to beneficiaries. This often requires selling estate assets, especially if there is insufficient cash. The law prescribes a strict order for applying assets to settle liabilities, and PRs must exercise their powers with care to avoid personal liability. Understanding the statutory hierarchy, the duties of PRs, and the tax consequences of asset sales is essential for SQE1.

Key Term: personal representative (PR)
The person(s) appointed to administer a deceased person's estate, including executors (named in the will) and administrators (appointed under intestacy).

Key Term: executor’s year
The 12-month period after death within which PRs are expected to collect assets, settle liabilities, and be ready to distribute; PRs are not bound to distribute earlier.

PRs should also adopt protective steps before distribution, including statutory advertisements to flush out unknown claims and, in most estates, waiting six months from the grant to reduce the risk posed by financial provision claims.

The Statutory Order for Payment of Debts and Expenses

PRs must apply estate assets in a specific order to pay debts, taxes, and expenses. This order is set out in the Administration of Estates Act 1925 and related rules.

Key Term: statutory order of application
The legally prescribed sequence in which estate assets must be used to pay debts, taxes, expenses, and legacies before distribution to beneficiaries.

The usual order is:

1. Property not disposed of by the will (including lapsed or disclaimed gifts)
2. Residuary estate (after setting aside funds for pecuniary legacies)
3. Property specifically appropriated for payment of debts
4. Property charged with payment of debts
5. Funds set aside for pecuniary legacies
6. Property specifically bequeathed or devised

PRs must exhaust each category before moving to the next. This ensures fairness and protects the interests of creditors and beneficiaries.

Key Term: pecuniary legacy
A gift of a fixed sum of money made by will to a beneficiary.

Key Term: residue
The remainder of the estate after funeral, testamentary and administration expenses, taxes, debts, and non-residuary gifts are satisfied.

Key Term: secured debt
A debt secured against a particular asset (for example, a mortgage), which as a default rule is discharged from the asset charged, unless the will shows contrary intention.

Secured debts are ordinarily borne by the asset to which they relate (e.g. a mortgage on a house), unless the will expressly states otherwise (e.g. a gift “free of mortgage”). Unsecured debts and the death inheritance tax charge on property vesting in the PRs are paid per the statutory order. A contrary intention in the will can vary this, for example by directing debt payment “out of residue” or stating that residue is “subject to” payment of debts.

Key Term: marshalling
An equitable doctrine allowing adjustment between beneficiaries where, as between themselves, one class should not bear a particular debt; a disappointed beneficiary is compensated from the residue.

Where PRs properly use the statutory order, beneficiaries may still seek marshalling if, between them, the burden should be redistributed. This adjusts entitlements but does not affect creditors.

Solvent and insolvent estates

In a solvent estate, all funeral, testamentary and administration expenses, debts, and taxes are paid in full (irrespective of whether legacies can then be paid in full). In an insolvent estate, unsecured creditors must be paid in the prescribed order, with categories abating rateably and PRs avoiding any preference between creditors of equal rank. Secured creditors have priority over their security.

Powers and Duties of Personal Representatives

PRs have wide powers to sell estate assets to raise funds for debts and taxes, but must act within their legal authority and fiduciary duties.

Key Term: fiduciary duty
The obligation to act honestly, with reasonable care, and in the best interests of the estate and its beneficiaries.

PRs must:

• Collect and secure all estate assets
• Identify and pay all debts, taxes, and expenses
• Apply the statutory order when selling assets
• Act in the best interests of the estate and beneficiaries
• Keep accurate records of all transactions

PRs must exercise reasonable care and skill (Trustee Act 2000 s 1), invest or realise assets prudently, and consider the standard investment criteria where relevant. They should select assets for sale by reference to the will’s terms, beneficiaries’ wishes, suitability of assets for any ongoing trust, and tax efficiency. PRs may appropriate assets to satisfy pecuniary legacies or beneficiaries’ shares if doing so is fair and does not prejudice others, and they should obtain consents where the statute requires them.

Key Term: appropriation
The process by which PRs allocate specific assets in or towards satisfaction of a legacy or share in residue, instead of paying cash.

PRs’ powers are fiduciary and must be exercised in good faith for the benefit of the estate as a whole. A sole PR can give a valid receipt for sale proceeds, but all PRs appointed should generally join in transfers of land and shares. PRs have no power to deal with assets passing outside the estate (e.g. joint property by survivorship or a life policy written in trust), although IHT on some such assets may be borne outside the estate.

Legal Protection for Purchasers

A purchaser who acquires estate property from PRs acting within their powers is generally protected from later claims by beneficiaries or creditors.

Key Term: purchaser protection
The statutory assurance that a buyer of estate assets from PRs obtains good title, provided the PRs act within their authority.

As a practical conveyancing point, where land is subject to beneficial interests, overreaching is achieved on a sale if capital money is paid to two trustees or a trust corporation. PRs should ensure that all appointed PRs join in transfers of land and shares. A buyer paying the right PRs need not investigate the internal application of proceeds and takes free of beneficiaries’ claims, provided the PRs act within their authority and the transfer is properly executed.

Tax Implications of Selling Estate Assets

The sale of estate assets can trigger tax liabilities that PRs must manage carefully.

Inheritance Tax (IHT)

IHT is charged on the value of the estate at death. PRs must pay IHT before distributing assets. If assets are sold to pay IHT, the proceeds are used for this purpose. Reliefs may apply, such as the nil-rate band, residence nil-rate band, and spouse/civil partner exemption. In appropriate cases, the instalment option may be available for IHT on land. Where quoted shares or land are sold at a loss within statutory time limits, relief may be available to reduce the IHT charge by substituting the lower sale price.

PRs can use the Direct Payment Scheme to pay IHT directly from the deceased’s UK bank/building society accounts; otherwise, funding can be obtained from beneficiaries or via bank loans, to be repaid from first available proceeds. Payment must precede the issue of most grants (subject to limited HMRC “grant on credit” discretion).

Key Term: Inheritance Tax (IHT)
A tax on the value of a deceased person's estate, payable before distribution to beneficiaries.

Capital Gains Tax (CGT)

Sales by PRs during administration can give rise to CGT on gains measured against the probate value (market value at death). Transfers by PRs to beneficiaries under the will or intestacy are not disposals for CGT purposes. PRs benefit from the estate’s annual CGT exemption for the tax year of death and the next tax year; thoughtful timing of sales can optimise use of this allowance. CGT rates and allowances change periodically, so PRs should check current rates when planning sales.

Key Term: Capital Gains Tax (CGT)
A tax on the profit made from selling estate assets that have increased in value since the date of death.

Income Tax

Income received by the estate during administration (e.g. rent, dividends, interest) is subject to income tax at the estate rates. PRs must file tax returns and pay any tax due before distribution. Certain interest on loans used to pay IHT on personalty vesting in the PRs may be deductible for a limited period. ISA tax advantages can continue for a limited time after death under the current regulations; PRs should verify current rules at the time of administration.

Key Term: estate income
Income generated by estate assets during the administration period, taxable as income of the estate.

Sale of Specifically Bequeathed Assets

If there is insufficient cash or residue to pay debts and taxes, PRs may have to sell assets specifically bequeathed to beneficiaries. This is only permitted after exhausting prior categories in the statutory order. PRs should consult affected beneficiaries and consider whether appropriation or alternative sales (e.g. of more tax-efficient assets) could meet liabilities whilst preserving specific gifts.

Worked Example 1.1

The estate of Mr. Patel consists of £15,000 in a bank account, shares worth £40,000 (bequeathed to his son), and a car worth £10,000 (bequeathed to his daughter). Debts and expenses total £30,000. There is no other property.

Can the PR sell the shares to pay the debts?

Answer:
Yes. The PR must first use the bank account. If this is insufficient, the PR may sell the shares (a specifically bequeathed asset) to pay the remaining debts, but only after exhausting the residue and other categories in the statutory order.

Worked Example 1.2

The will gifts “my home at 8 Oak Lane to A free of mortgage.” The house is subject to a £100,000 mortgage. Residue passes to B. There is sufficient residue otherwise to meet unsecured debts and expenses.

Who bears the mortgage?

Answer:
The express “free of mortgage” wording shows contrary intention. The mortgage is discharged from residue before distribution, so B’s entitlement reduces accordingly. Absent contrary intention, the mortgage would have been borne by the property gifted to A.

Worked Example 1.3

The estate is insolvent. Funeral and administration expenses total £6,000. There are preferred debts (employees’ wages) of £2,400, ordinary debts (including HMRC) of £30,000, and interest on debts £3,000. There are no secured debts and total assets realised are £35,000.

How should PRs apply the assets?

Answer:
The PRs pay in order: reasonable funeral and administration expenses (£6,000), preferred debts (£2,400), ordinary debts (£26,600 pro rata), then interest, if any assets remain (none here). Each class abates proportionately, and no beneficiaries receive anything.

Worked Example 1.4

PRs sell quoted shares. Probate value at death was £50,000. The shares are later sold for £62,000 within the first tax year of administration. The estate has no other disposals in that tax year and is entitled to the annual CGT exemption.

Is CGT payable?

Answer:
Yes. The gain is measured against probate value: £12,000. The estate can set its annual exemption first (if not used elsewhere), and any remaining gain is taxed at the estate rates.

Worked Example 1.5

A will leaves a £25,000 pecuniary legacy to C and residue to D. The estate holds a painting valued at £25,000 at death and £30,000 cash. D asks PRs to retain the painting for C instead of selling assets.

Can PRs appropriate the painting to satisfy C’s legacy?

Answer:
Yes, provided appropriation is fair, does not prejudice others, and statutory/consent requirements are met. PRs may appropriate the painting towards C’s pecuniary legacy valued by reference to its proper value, and adjust cash accordingly.

Legal Consequences of Breach

If PRs fail to follow the statutory order or act negligently, they may be personally liable for any loss to the estate or beneficiaries. They may also be liable for unpaid taxes or for selling assets without authority.

At common law, maladministration can amount to a devastavit (waste), exposing PRs to personal liability to restore loss. In insolvent estates, PRs must avoid preferring one creditor in the same category over another; paying a lower-ranking debt knowing of higher-ranking debts can amount to an implied warranty that assets suffice to meet higher debts and may lead to personal liability if they do not. The court may, in appropriate cases, relieve PRs who acted honestly and reasonably.

Exam Warning

If a PR distributes assets to beneficiaries before paying all debts and taxes, they may be personally liable to creditors or HMRC for any shortfall. Always ensure liabilities are settled first.

Practical Considerations and Tips

Revision Tip

Always check for sufficient liquid assets before distributing the estate. If necessary, consult professional advisors on tax and asset sales to avoid errors and liability.

PRs should:

• Obtain professional valuations early (land, quoted/unquoted shares, chattels) to assess sale options and potential CGT
• Consider IHT loss on sale reliefs and the timing of sales to optimise CGT exemptions
• Evaluate appropriation to satisfy legacies or residue without unnecessary sales
• Engage beneficiaries—especially where sales will affect specific gifts—and keep clear records
• Place statutory advertisements to protect against unknown creditors or beneficiaries and consider insurance or court orders (e.g. Benjamin orders) if someone cannot be traced
• Be cautious with insolvent estates: follow the statutory priority and avoid preferences
• Delay distribution until six months after the grant where financial provision claims may be made, or retain sufficient funds

Key Term: insolvent estate
An estate with insufficient assets to pay funeral, testamentary and administration expenses, debts, and liabilities in full; beneficiaries receive nothing.

Key Point Checklist

This article has covered the following key knowledge points:

• The statutory order for applying estate assets to pay debts, taxes, and expenses must be strictly followed.
• Secured debts ordinarily follow the charged asset unless a contrary intention appears in the will.
• The doctrine of marshalling may adjust burdens between beneficiaries without affecting creditors.
• Personal representatives have wide powers to sell assets and to appropriate, but must act within fiduciary duties and with reasonable care and skill.
• Purchasers from PRs are protected if the PRs act within their authority; ensure proper joining for transfers and valid receipts.
• The sale of estate assets can trigger Inheritance Tax, Capital Gains Tax, and Income Tax liabilities; reliefs and exemptions may apply.
• Distinguish solvent and insolvent estates; in insolvent estates apply the statutory order for unsecured creditors and avoid preferences.
• Protective steps (statutory advertisements; prudent timing relative to financial provision claims) reduce PRs’ exposure.
• PRs may be personally liable for losses if they breach their duties or distribute assets before settling liabilities.

Key Terms and Concepts

• statutory order of application
• pecuniary legacy
• personal representative (PR)
• fiduciary duty
• purchaser protection
• Inheritance Tax (IHT)
• Capital Gains Tax (CGT)
• estate income
• executor’s year
• residue
• secured debt
• marshalling
• appropriation
• insolvent estate