How to Save Capital Gains Tax on Inherited Property

Property owned by a deceased at the time of death generally devolves to the Legal Personal Representative (LPR) of the deceased’s estate. However, once the estate administration is complete, the property or its net sale proceeds ultimately pass on to the beneficiaries according to the will. Various rules apply to calculate the capital gains tax on inherited property to minimise the capital gains liability.

Capital Gain on death is rolled over and deferred till the LPR or the beneficiary sells the property except when the property passes to:

a tax-exempt entity (e.g., a charity); or
a complying superannuation fund; or
foreign resident (except for Australian “taxable property” like real estate)

In other words, any unrealised capital gain or loss on a property at the time of death is deferred until the gain is eventually realised. However, where the assets devolve to a tax-advantaged structure that will not pay tax when the asset is sold, the capital gain crystalises on death and is not rolled over. In this case, any capital gains tax on inherited property becomes the liability of the deceased estate.

Various rules apply to calculate the capital gains depending upon the date of death, the date of acquisition of the property by the deceased and the actions of the persons inheriting the property. These rules present scope for tax planning to minimise the capital gains liability. Some of these strategies are discussed below.

CCGT Exemption for Inherited Main Residence

One of the most common assets owned by people just before their death is their main residence or at least a property that, at some point, was their main residence. The property inherited will retain its main residence status, and a full or partial exemption may be available, saving capital gains tax on inherited property, but this depends upon the residential status of the deceased and property’s treatment by the beneficiary.

Full exemption for the main residence

The main residence exemption will continue if:

the deceased was an Australian tax resident; and
the house was the deceased’s main residence for the full period and was not used for income-producing (e.g. rental) purposes; and
person inheriting the house either continues to live in the main residence from the date of death or sells the house within two years from the date of death.

Partial exemption for the main residence

Where the deceased’s main residence was partly used for income-producing purposes (e.g. rental) or was not his main residence for the full period, only a partial main residence exemption will apply on a pro-rata basis.

In this case, the house’s cost is deemed to be the market value at the date of death (and not the original cost to the deceased). This itself can represent significant savings as tax will effectively be charged only on the gain that accrues after death.

50% CGT discount

The deemed date of acquisition for the beneficiary for availing the 50% reduction is the original date of acquisition by the deceased, not the date of death, the date of transfer of title, or the date of death. This provided more leverage because if the deceased has held the property for 12 months before death, you will be able to sell the property immediately on inheriting the title and be eligible for the 50% reduction in your capital gains.

Tax Tip

Where the house was purchased before 20 September 1985, there is no requirement for the house to have been the deceased’s main residence at all. In this case, it will be exempt even if the house were not a main residence or if the deceased was a non-resident, provided the other two conditions are met.

The 6-year absence rule for the main residence can apply, provided the beneficiary has first made the dwelling their main residence.

Non-resident Australians are not eligible for the main residence exemption. Therefore, if the main residence is inherited from a non-resident, this exemption will not apply.

Capital Gains Exemption on inheriting a pre-CGT investment property

The capital gains tax regime came into operation only on 20 September 1985. Capital assets acquired before that date are not subject to tax. Therefore, any asset bequeathed by the deceased will retain its CGT-free status and may be inherited fully or partly exempt from capital gains liability, depending upon the date of death.

Full exemption: where the date of death is before 20 September 1985

Where the date of death is also pre-CGT, the property is inherited completely free of any capital gains, even if the beneficiary subsequently sells the property.

Partial exemption: where the date of death is before 20 September 1985

However, where the date of death is after 20 September 1985, the pre-CGT property will be deemed to be acquired at the market value on the date of death. This means that when the capital gain is realised on selling the property, only gains accruing after the date of death will be taxed.

50% CGT discount

The 50% reduction in capital gains is available if you retain the property for at least 12 months from the deceased’s death date.

Capital Gains on inheriting a post-CGT investment property

Where the deceased had acquired the asset after the commencement of the CGT regime, i.e., after 20 September 1985, the Legal Representatives are deemed to have inherited the asset at the cost of the deceases.

Even though the full capital tax will apply when you sell the property, you can reduce the tax by claiming any appropriate portion of the cost of obtaining probate, legal costs to acquire the title, and renovations to the property. It is, therefore, important to keep proper records and obtain the cost of the acquisition of the property to the deceased.

50% CGT discount

The 50% reduction in capital gains is available if you retain the property for at least 12 months from the original date of acquisition by the deceased. This provided more leverage because if the deceased has held the property for 12 months before death, you will be able to sell the property immediately on inheriting the title and be eligible for the 50% reduction in your capital gains.

Inheritance of property by tax-free charities and superannuation funds

The rollover of unrealised capital gain is not available where the property is inherited by a tax-exempt entity like a church, public hospital, not-for-profit charity, etc., or a super fund.

This is because when a tax-advantaged entity will ultimately sell the inherited asset, it will not pay any capital gain or pay a much-reduced capital gain. Therefore, capital gains are triggered to a deceased estate.

Where the charity is a Deductible Gift Recipient (DGR), the tax deduction for the donation to the charity will also not be available.

The capital gain will accrue to the deceased and will need to be included in the date of death tax return.

Tax Tip

Where possible, it may be prudent to gift the asset to the DGR Charity before death. This way, even though the full capital gain will apply, the deduction can be claimed for the donation, which will generally be higher than the capital gain.

Expert Advise on Capital Gains Tax on Inherited Property

We at Nav Accountants and Advisors are a firm of accountants specialising in property. We can help you understand more about how capital gains tax on inherited property works and how you can save money from tax.

We are happy to offer you a consultation by clicking the link below.

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