Capital gains tax when inheriting a principal residence
Most people are aware that their principal (family) home is not subject to capital gains liability should you decide to sell and relocate. Most would also understand that the sale of an investment property (ie, not a principal residence) can be subject to a capital gain assessment at the time of sale. So what are the implications of selling a home which you have inherited, particularly if you are not occupying the property yourself at the time of sale.
When a property is transferred from a deceased person’s estate to a beneficiary, the name on the title deed will be changed but that transfer itself is not assessable for capital gains tax (CGT) liability by the Australian Taxation Office (ATO). It should be noted however that once that transfer is effected, the beneficiary will be considered the legal proprietor of the asset and the value of that asset, or your share of it, will be assessable for Centrelink benefit entitlements, for example.
Should the beneficiary subsequently decide to sell the property to another party, it is possible that a capital gains assessment and liability will result, however there are a variety of scenarios and circumstances which need to be considered to determine liability.
Some background. Capital gains taxation assessment was introduced on September 20,1985 and broadly applies to all assets acquired on or after that date which do not meet the principal residence definition (ie, the owner is not living in the property at the time of sale).
Assets purchased prior to September 20, 1985
If a property was acquired by the deceased prior to September 20, 1985 it will be exempt from CGT assessment and liability regardless of whether it was the deceased’s own home or an investment property. The beneficiary will inherit the property at its market value as at that date of death of the deceased and will have a two-year window (from the date of death; not the date of property transfer) to sell the property before it would be assessable for CGT liability. This exemption will be maintained even if the beneficiary opted to rent out the residence to tenants during the two-year window.
Should the beneficiary decide to sell the property after two years have expired since the date of death, a CGT assessment would be based on the increase in property value from the date of death until the date of sale.
Assets purchased after September 19, 1985
If the property was acquired after this date, the beneficiary will still enjoy a two-year window where the sale will be exempt from CGT assessment but only if the following conditions are satisfied:
- The property was the residence of the deceased at the date of their death AND
- The property was not being used to generate assessable income at that date.
Interestingly, the beneficiary may generate rental income from the property during the two-year window without triggering a CGT liability, but condition two (above) must be satisfied to maintain exemption.
Can a beneficiary extend the ‘two-year window’?
Should a beneficiary opt to occupy the inherited property as their own residence during the two-year period after the date of death of the deceased, then the property will continue to be exempt for CGT liability for the period of their occupation.
How are joint tenants treated for CGT purposes?
Where a property is owned by ‘joint tenants’ (most commonly spouses) and one of the owners dies, their share of the property will pass to the surviving owner. In this instance it is common that the surviving owner would continue to reside in the property, thereby extending the principal residence situation and maintaining an exempt CGT liability for themselves.
In this case however, while no CGT liability will be calculated on that transfer of ownership, the transfer is recorded and it is considered that the surviving owner acquired their own share at the original acquisition date and acquired their partner’s share at the date of death of the partner.
Case study
Fred and Wilma purchased their home in January 1990 for $75,000. Fred passed away in January 2005 and the property was transferred into Wilma’s name then. Wilma was advised to obtain a valuation of the property at that time which was assessed at $250,000. Wilma lived there until she died in 2014. The property was inherited by their widowed daughter-in-law, Pebbles. Pebbles did not live in the property. After some deliberation she has now decided to sell the property and has secured a contract for $555,000. As the two-year window period has passed, the property will be assessable for CGT liability. The cost base will be a combination of Wilma’s 50 per cent acquisition in January 1990 ($37,500) and her acquisition of Fred’s 50 per cent interest in January 2005 ($125,000) – a total of $162,500.
After allowing for deduction of selling costs of $12,500, Pebbles will be assessed on a capital gain of $380,000 (being $555,000 less costs of $12,500 less cost base of property of $162,500). As the property had been owned for more than 12 months, the 50 per cent general CGT concession will apply, so Pebbles’ liability will be calculated on a gain of $190,000. Even if she has no other assessable income at the time of sale, the tax liability on that transaction would exceed $60,000 (including Medicare levy).
Summary
This is a complex area where we are seeing regular examples of clients being confused by their options or worse, only becoming aware of the implications after the event and perhaps not realising as much capital from a transaction as they might have expected.
The position is often further confused by the requirements of multiple beneficiaries (often involving people in different tax brackets) and families with members who have disability trustee status or aged care requirements, which can influence decisions around if and when to sell a family residence.
Should you require further clarification, we would welcome the opportunity to discuss your specific situation and outcome requirements with you and would urge you to arrange an appointment with us before these decisions are made.