Financial planners are often asked to assist clients who are the beneficiaries of a deceased’s estate. It’s a challenging task that’s often complicated by the need for an objective conversation with people who are facing a difficult time.

This article is for educational purposes only and is no longer available for CPD hours.

In these instances, it’s helpful to understand the special taxation rules relating to homes acquired under a deceased estate, so your client can be aware that their decisions may either incur or minimise capital gains tax (CGT).

This article looks at the implications of CGT on the beneficiary’s inheritance of the main residence upon the death of the owner.

Generally, no CGT applies when a deceased person’s assets are distributed to their beneficiaries. From the ATO’s perspective when someone dies, a capital gain or loss is disregarded when a property passes to:

• the deceased person’s executor or other legal personal representative.
• the deceased person’s beneficiary.
• from the deceased’s legal personal representative to a beneficiary.

However, there may be CGT implications when the executor or beneficiary sells the inherited asset to a third party.

Where a former home is included in the deceased’s estate, it’s important to obtain the benefit of the CGT exemption which applies to the main residence, or to preserve the CGT exemption which applies to pre-CGT assets.

The two main factors that affect the CGT exemptions are related to the answers to these questions:

1. When did the trustee or beneficiary sell the property?

If it was within two years of the deceased’s death, it will be easier to obtain the exemption.

2. When did the deceased acquire the property?

If it was before 20 September 1985, an exemption may be available as this was a pre-CGT asset. In this case, CGT exemption applies irrespective of whether the deceased used the property as a main residence or not. If it was acquired after 19 September 1985, the conditions for exemption are much stricter.

Two-year rule

If the property was acquired by the deceased prior to 20 September 1985 and sold within two years of the date of death, the property is exempt from CGT. This exemption applies even if it was not the deceased’s main residence or if the dwelling is rented out during the two-year period after death.

If the property was acquired by the deceased after 19 September 1985 and sold within two years of the date of death, the property is exempt from CGT only if:

• it was the deceased’s main residence at date of death; and
• it was not used to produce assessable income at that date.

When assessing this two-year period, where the property is sold under contract, settlement (rather than exchange of that contract) must occur within the two years.

Example

Ross purchased and moved into his main residence on 26 October 1986 and occupied it until his death on 16 May 2013.

His beneficiary, Monica, rented the home to a third party shortly after his death, selling it on 10 April 2015.

As the home was Ross’s main residence throughout the period of ownership and as it was sold within two years of his death, it is wholly exempt from CGT on sale, notwithstanding the fact it was rented out after his death.

Cost to the beneficiary of acquiring the property

For the beneficiary acquiring a property the deceased had owned, there are special rules for calculating the cost base of the property. These rules apply in calculating any future capital gain or capital loss when a CGT event happens to the property.

The cost base of a property or its acquisition cost is its market value at the date of death, if the property:

• was acquired by the deceased before 20 September 1985; or
• passes to the beneficiary after 20 August 1996 (but not as a joint tenant), and it was the main residence of the deceased immediately before their death and was not being used to produce income at that date; or
• passes to the trustee of a Special Disability Trust.

In any other case, the cost base is the deceased’s original cost base.

Clients are advised to contact the deceased’s tax adviser to obtain the relevant details.

Special rules where home owned as joint tenants

While an asset owned as joint tenants automatically passes to the survivor on the death of the other joint tenant, CGT law treats them as tenants in common. This may result in a deemed acquisition/disposal of the joint tenant’s share.

Where a home was acquired before 20 September 1985 and one joint tenant dies after that date, the survivor is deemed to have acquired the deceased’s share after 19 September 1985.

Example

Con and Rachel purchased their home on 8 August 1983 as joint tenants. Rachel died on 20 January 2015.

While Rachel’s share of the home automatically passed to Con on her death, for CGT purposes, he is deemed to have acquired half the home on 20 January 2015 for its market value on that date.

Case study

Ted will soon inherit his mother’s main residence. The former family home was purchased for $100,000 in the eighties, and is now valued at $1 million. Ted is an only child and the only living dependant.

What are Ted’s options under the following scenarios?

Scenario 1: Ted’s mother bought her home before 20 September 1985

If Ted’s mother bought her home before 20 September 1985 and if the property was his mother’s main residence at the date of death, what are the CGT implications for Ted if he plans on disposing of the property:

• within two years from the date of death of his mother?
• after two years from the date of death of his mother?

If Ted sells it within two years from the date of death, there are no CGT implications, as this is originally a pre-CGT asset.

If Ted sells the home after two years, then if the property was his main residence from his mother’s death until his ownership period ends, there would be no CGT.

If he didn’t live in the home, CGT may apply with the cost base set at market value at the date of death. There is no CGT pro-rata exemption for the first two years.

In this case, if Ted sells it for $1.1 million three years after death, there will be a net capital gain of $50,000 ($1.1 million – $1 million) x 50 per cent taxed at his marginal tax rate.

TIPS: Ted should be advised to obtain the market value of the inherited property as at the date of death of his mother.

There may be many practical reasons why a sale of property may not fall within the two-year disposal concession, even where the original intention was to sell within the two-year window.

Scenario 2: Ted’s mother purchased her main residence on or after 20 September 1985

If the property was his mother’s main residence at the date of death, what are the CGT implications for Ted if he plans on disposing of the property:

• within two years from the date of death of his mother?
• after two years from the date of death of his mother?

For the two-year disposal concession period to apply, because this was originally a post-CGT asset, there is a requirement that Ted’s mother had lived at home and had not rented out her home on her date of death. So long as he sells it within this concessional period, it’s irrelevant whether he has lived in the home or has rented it out during his period of ownership.

If Ted sells the property after two years, then CGT may apply with the cost base being the same as his mother’s original purchase price. There is no CGT pro-rata exemption for the first two years and the 50 per cent general CGT discount applies from her original date of purchase.

What if the property was income producing at the date of his mother’s death?

As the property was a post-CGT asset and income producing at date of death, Ted will not be entitled to the two-year concession period.

CGT applies on sale with the cost base the same as his mother’s original purchase price. The 50 per cent general CGT discount applies from her original date of purchase.

What if the property was rented out by Ted?

CGT does not apply, so long as he sells within the concessional two-year period. This is except if Ted’s mother did not live in the property at her date of death and rented it out. That is, since the property was originally a post-CGT asset and income producing at the date of her death, CGT may apply.

Watch out for the traps when it comes to the family home

A large part of intergenerational wealth transfer will involve the family home. The tax concessions from home ownership shouldn’t be ignored or assumed to carry across from the deceased to the surviving beneficiary. Understanding the issues and alternate options available will assist clients and their beneficiaries to ensure that their estate planning goals and objectives can be met tax efficiently.

While taxation should not be the main reason for how clients make their decision with respect to their family home, given the family home may be one of the largest assets for clients, paying attention to the taxation concession available helps preserve the value of this asset for clients and their beneficiaries.

Clients are encouraged to keep adequate proper records for tax purposes, and make these records available for the beneficiaries who they intend to inherit the property. This is good practise, even if their intention may be to reside in their home for the full-term of their ownership.

For beneficiaries who stand to inherit the home, knowledge of when the deceased purchased their home, and understanding how the two-year concessional period operates, can bring a valuable tax concession to be mindful of.

William Truong, Technical Services Manager, IOOF.