How does the ATO work out the capital gains tax obligation of a deceased estate? Kirk Wilson explains
We all know that Australia no longer has death duties. We don't even have a form of 'de-facto' death duty. Instead, the beneficiaries and executors of an estate, in effect, 'step into the shoes' of the deceased so that capital gains tax will usually only apply when a beneficiary who inherits property later sells or transfers it, or where the executor of the estate sells or transfers the property to someone other than a beneficiary of the estate.
Furthermore, CGT doesn’t apply to the primary residence of the deceased at their time of death (and was not then being used to produce income) if it is sold within two years of their death – regardless of how it is used in that two-year period. The same rule also applies if it is sold or transferred after it has been lived in by a surviving spouse or a beneficiary who inherits it or a person with a "right to occupy" it under the will.
Keeping the structure relatively simple will save you both money and headaches in the long run.
How CGT is calculated
Beyond these concessions, how will a deceased’s real estate, aside from their residence, be subject to CGT when it is later sold?
Given an increasing number of retirees’ investment portfolios include investment properties and holiday homes, how will this be treated?
Homes bought before 20 September 1985
Properties bought before 20 September 1985 ('pre-CGT') like the deceased's home at date of death won't be subject to CGT if it is sold either within two years of the deceased's death or after it has been lived in by a surviving spouse or a beneficiary who inherited it or a person with a right to occupy it.
However, if neither of these things happen, then any capital gain (or loss) will be calculated by reference to a 'deemed cost' equal to the property's market value at the time of the deceased's death – which, nevertheless, will help in abating any capital gain on its later sale or transfer.
Homes bought after 20 September 1985
In the case of an investment property or a holiday home that has been bought or acquired by the deceased 'post-CGT' the situation is quite different.
For a start there is no CGT exemption on its later sale or transfer, at least not a complete one.
Further, the deemed cost of the property will be its original cost to the deceased. In other words, it will be as if the beneficiary who inherited the property (or the executor as the case may be) bought or acquired the property for the same price as the deceased (and at the same time).
This may in turn mean that there may be a large capital gain on the property.
How you can reduce CGT
There are a few things to remember that may help to reduce this capital gain.
1. CGT discount concession
This applies to tax only half of the capital gain a person makes if they have owned an asset for more than 12 months. Even more generously, where a benefi ciary has inherited a post-CGT property, then the period that it was owned by the deceased will also be taken into account for the purposes of this 12 months holding rule.
2. Cost of buying and selling
There are a range of expenses related to acquiring and selling an inherited property that can be included in the deemed cost to help reduce any capital gain.
Apart from costs such as real estate and legal fees on sale of the property, costs incurred by an executor while they are holding the property before transfer to a benefi ciary can also be included in the benefi ciary's deemed cost.
Typically, this would include council rates, land tax and insurance on the property. But it may also include, for example, legal fees that an executor might incur in defending a challenge to the estate.
Can you avoid paying CGT?
Is there anything that can be legitimately done so as not to have to pay CGT on an inherited investment property or holiday home?
It is not uncommon these days for a person who has, say, lived all their life in their pre-CGT home to decide to live in their post-CGT holiday home in their retirement.
In this case, when they pass away, that holiday home will be their home at their date of death – with the result that there will be no CGT if it is either sold within two years of their death or after it has been lived in by a surviving spouse or a benefi ciary who inherits it etc.
And what's more, the same rule can apply to the original pre-CGT home, regardless of how it was used after the deceased moved out.