They say trust is hard earned but easily lost. The same can be said for a person’s wealth.
Death and taxes (the only two certainties in life) are topics not often discussed within family groups around the dinner table. However, I strongly advocate that family members have discussions regarding wills and wishes while they can, to avoid unintended tax implications eroding the asset pool upon succession due to a lack of communication or well considered advice.
Generally, one of the largest asset classes people will own in their lifetime is Australian real property, and in particular, the family home. It is expected that around $3.5 trillion in family wealth (certainly involving real property) will be passed onto the next generation over the coming two decades, resulting in a real need for competent advice - given it is likely that at some point you, or someone you know will either be passing on an interest in a property, be asked to act as an executor of a deceased estate involving property, or inherit an interest in a property.
If you are looking to pass on your interest in a property, early collaboration with your professional advisors (such as accountants and lawyers) will ensure your wishes are mapped out and executed as intended.
If you are acting as a Legal Personal Representative (LPR) or have inherited an interest in a property, understanding its history and the future intentions of beneficiaries are important to efficiently manage tax outcomes. Critical questions include: Will the property be kept or sold by beneficiaries? Will it be used by the beneficiaries? And what are the historical acquisition details of that property? This is because the Capital Gains Tax (CGT) outcomes on property transfers depend heavily on the facts. One of the practical difficulties in dealing with real property transfers (especially where older properties are involved) is obtaining access to accurate records.
Understanding how the property is legally owned is the first step in any situation involving transferrals. This is because whether it was held solely by an individual, jointly, as tenants in common or in another entity, will determine whether the property forms part of a deceased estate in the first place. For example, if an individual owns a property jointly with another person, interest will automatically pass to the surviving owner on the other’s death and will therefore not form part of the deceased’s estate. Conversely, the same property being held as tenants in common will result in the deceased’s share forming part of their estate to be passed on to beneficiaries in accordance with the deceased will. Therefore, it is clear to see why it is so important to get these issues sorted during an individual’s lifetime, ensuring their wishes are carried out after they are gone.
To demonstrate the various outcomes and the benefit appropriate tax and succession planning can have on ensuring a deceased’s wishes are fully and most effectively fulfilled, let’s visit a few simple scenarios assuming a deceased Australian tax resident wholly owned an interest in an Australian property.
Passing on a main residence
The main residence exemption is an extremely generous concession where the increase in value on sale of the family home can be fully exempt from CGT. The mechanism by which this concession interacts with transfers of property, and death in particular, can be complex.
If we assume the scenario of an individual wholly owning a property which was their main residence for the entire period of ownership up until death, beneficiaries may be able to access an extension of the deceased’s main residence exemption (i.e. the sale of the property could possibly be fully exempt from CGT in their hands) if:
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They sell the property within two years from the deceased’s date of death (note that this time limit can be extended in some circumstances).
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A spouse of the deceased, a beneficiary of the property, or another person granted a right to reside in the property under the deceased’s will, had occupied the property from the deceased’s date of death until the date of sale.
It is important that beneficiaries or LPRs work with their accountant to properly understand the operation and practicalities of these concessions. In situations where the full main residence exemption is not able to be extended, the result may be a partial exposure to CGT for beneficiaries.
As long as the inherited property was the main residence of the deceased and was not used to produce income at that time, its cost base for beneficiaries becomes its market value at the date of the deceased’s death.
If the property was not the main residence of the deceased at the date of death, the following outcomes may eventuate for a beneficiary:
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If the property was originally purchased by the deceased pre-CGT (before 20 September 1985) – the beneficiary will inherit the property with a cost base equal to the market value of the property at the date of the death. A valuation using a licensed valuer will be required.
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Post CGT property – the beneficiary will inherit the cost base of the deceased. Given the explosion in the value of properties over the past few decades, the cost base could be minimal (comparatively to the gain) which is why accurate records are important. Records of any improvements conducted, or expenses incurred by the deceased which could form part of the cost base are crucial as they may reduce the taxable gain on the property’s eventual disposal.
If the main residence was used to produce income by the deceased (i.e. rented or used as part of a business), or there was differing legal ownership, the outcomes above can change. For example:
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A main residence where one room has been rented out may only enjoy a partial main residence exemption.
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Where one owner of a pre-CGT jointly held property dies, this ordinarily means their interest automatically passes to the surviving owner. In this scenario, the property would not form part of the deceased’s estate and for tax purposes becomes two separate assets – one which could be a pre-CGT and one a post-CGT asset. This will interact with how the survivor uses the property going forward.
Investment properties
Assuming an investment property was never used as a main residence, a beneficiary will be subject to CGT on any gain made on the disposal of an inherited investment property. As CGT applies, it is important the correct cost base of the property is determined. This will involve discovery and analysis of historical ownership records presumably by the LPR who would ordinarily be best placed to address this.
The investment property could also be a pre-CGT asset, in which case its cost base in the hands of a beneficiary will be the market value at the date of the deceased’s death.
Other issues to note include:
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Under Australian taxation law, once the owner of a pre-CGT asset has passed away, it will lose it pre-CGT status.
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The 50% general discount on CGT can be enjoyed by an individual Australian resident beneficiary on the disposal of a deceased’s investment property, provided the time between the date of acquisition for tax purposes by the deceased and the contract date for the sale of the property exceeds 12 months. A non-resident beneficiary will likely not be able to access the 50% discount.
The fact pattern may include situations not contemplated above which can alter the outcome, such as the provision of life and remainder interests, deeds of arrangement, or situations where a pre-CGT property has been significantly improved. Further, properties held in companies, superannuation funds, or other trusts can alter the outcome and the comments in this article also assume the property was always held on capital account. Transfer duty must also be considered in which the outcomes will differ depending which State or Territory the property is located.
As a general point, there are subtle complexities littered throughout the legislation dealing with CGT on properties and this article is not intended to cover all situations. Gathering all the historical information about the property, such as its purchase history and how it has been used is the first critical step which often takes a lot of time and hard work, but can certainly be worth the effort where older properties or main residences are involved.
Simply put, whether you are looking to pass the interest in a property you own, or you have inherited a property, in either case it is always well worth seeking expert advice early on to ensure there are no nasty surprises down the road.
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If you would like further information or assistance, please contact your local Moore Australia advisor.