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Deceased Estates & The Main Residence CGT Exemption

When someone passes away, a wide range of financial considerations can arise. From funeral expenses and insurance policies to the tax implications around inherited assets, the associated complexities are most unwelcome at what is already a particularly stressful time.

In this article, we’ll be focusing on that last example – particularly how Main Residence Capital Gains Tax (CGT) exemptions apply to inherited dwellings. While the application of the rules around the exemptions seem fairly straightforward on the surface, different situations and timelines can affect the overall tax outcome.

The key takeaway is that you cannot assume an inherited main residence will be tax free when sold.

Full CGT Exemption

In order to fully qualify for the Main Residence CGT exemption when selling a property inherited from a deceased estate, there are some conditions that need to be met. Generally speaking, a full exemption applies if the deceased acquired the property before 20 September 1985 (‘pre-CGT’), or, post-CGT properties that were always the deceased’s main residence just prior to their death.

Don’t forget the two-year rule:

Importantly, the beneficiary must dispose of the property within two years of the deceased’s death (based on settlement date). An exception to this rule exists where the dwelling was used as the residence for the deceased’s spouse; a person who had the right to live there based on the deceased’s will; or the beneficiary themselves (provided the property was not used to produce income).

A couple of solutions:

There is also some guidance on managing your tax affairs as if the Australian Taxation Office (ATO) had allowed up to an additional 18 months beyond the two years to satisfy the conditions for a CGT exemption. The full list of “Safe Harbour” conditions can be found here.

The ATO also has discretion to allow an extension of the two-year rule, if there were factors outside the beneficiary’s control that prevented the dwelling being sold and settled within that timeframe allowed – even if this took longer than the safe-harbour extension.

The rewards for assessing the two solutions above can be significant. This is because any capital gain in relation to the inherited dwelling would be 100% tax-free if the self-assessment evaluation or Commissioner’s discretion application were to be successful.

Partial CGT Exemption

Given the criteria above, it is reasonable to think that there would be plenty of situations where qualifying for a full exemption wouldn’t be possible. However, a partial exemption may be available for those who don’t meet the above, or if the dwelling was used to produce income at some stage (e.g. rented for a period to time).

For example, if the deceased acquired the property after 20 September 1985 and it was not their main residence just before they passed away, a partial exemption may apply. Similarly, if the property was being used to produce income, either before their death; or between their death and the settlement date of the sale of the home, a partial exemption may be applicable.

TIP: If a partial exemption is available then the focus may shift towards maximising the cost base of the property (thus reducing the capital gains tax liability).  As it can be difficult to reconstruct the records after the fact, it is ideal that adequate property records are compiled/retained by the property owner during their lifetime.

The Non-Resident Conundrum:

In recent years, there have been numerous changes that increase the capital gains tax exposure for non-resident taxpayers disposing of properties (including their main residence).

These changes translate to further issues for Australian residents inheriting properties from overseas, or, non-resident beneficiaries receiving properties located in Australia. Some examples include the loss of the main residence exemption altogether, a reduction to the 50% CGT discount, additional Foreign Landholder Duty, Income tax and withholding tax obligations.

Other Considerations

While the examples and conditions above cover the majority of circumstances, there are some other factors that influence the application of a full or partial Main Residence CGT Exemption (or no exemption at all).

Scenario A: If the deceased died before 20 September 1985 (and therefore the beneficiary inherited the dwelling before said date), any capital gains made upon disposing of the property are exempt from CGT.

Scenario B: If the deceased acquired the property before 20 September 1985, but died after 20 September 1985, CGT does not apply if either of the following conditions are met:

1. The beneficiary disposes of the home within two years (regardless of whether it was the beneficiary’s main residence or being used to produce income); or
2. The dwelling was not used to produce income and was the main residence or either the beneficiary; the spouse of the deceased from immediately before their death; or an individual who had the right to live there based on the deceased’s will.

Scenario C: If the dwelling was acquired by the deceased on or after 20 September 1985, a full CGT exemption may be granted if either of the following apply:

1. The dwelling was passed to the beneficiary on or before 20 August 1996, Scenario B’s main residence condition is met, the deceased held it as their main residence from when they acquired it until their death, and it was not used to produce income
2. The dwelling was passed to the beneficiary after 20 August 1996, Condition 1 or Condition 2 from Scenario B is met; and just before the deceased passed away it was their main residence and not being used to produce income.

Next Steps and How MP+ Can Help

As the saying goes – “By failing to prepare, you are preparing to fail”. The key to minimising tax and easing headaches, especially when it comes to estates and property, is careful pre-planning and swift estate administration. The Tax Advisory team at McKinley Plowman works closely with legal experts, to ensure that all of the necessary structures and documents are in place so that when the time comes, you won’t pay any more tax than you need to, and the process will be as seamless as possible from start to finish.

When dealing with foreign inheritance / non-resident beneficiaries there are a raft of complex issues that need to be considered.  McKinley Plowman can provide specialist in-house advice, and, co-ordinate overseas advice through its affiliation with the MSI Global Alliance (if required).  This process streamlines the resolution of international matters – particularly where the estate or beneficiaries are located outside of Australia.

If it’s been a while since you last updated your wills, or are yet to take that step, don’t hesitate – contact us today via our website or call us on 08 9301 2200.

Further Reading/References:

https://www.ato.gov.au/General/Capital-gains-tax/Deceased-estates-and-inheritances/Inherited-dwellings/CGT-exemptions-for-inherited-dwellings/

https://www.ato.gov.au/law/view/document?DocID=COG/PCG20195/NAT/ATO/00001

written by:

Steven Lisle

Tax Manager Steven Lisle has been part of the McKinley Plowman team since 2007, and in that time has built his repertoire upon delivering industry leading, up-to-date international and Australian tax strategies and consulting services. Steve's clients enjoy the optimised tax outcomes he provides them, especially where complex structures could otherwise lead to significant tax obligations.