Reducing tax on property inheritance comes down to proper planning
With many clients unaware of the hefty tax bills that can apply to property after death, it’s important to plan ahead for these issues, says an advisory firm.
Many people planning to leave their house to their children don’t realise there is a hefty tax bill that may apply.
Careful estate planning can minimise that tax liability, according to Nitin Vashisht, director of Nav Accountants and Advisors.
“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,” Mr Vashisht said.
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 in accordance to the will.
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); 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,” he said.
“However, where the assets devolve to a tax-advantaged structure that will not pay tax when the asset is sold, the capital gain crystalises [sic] on death and is not rolled over. In this case, any tax on capital gains becomes the liability of the deceased estate.”
There are a number of rules that 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 and these rules present scope for tax planning to minimise the capital gains liability.
Full exemption for the main residence 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 purposes.
It will also be exempt if the 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.
A partial exemption for the main residence will apply where the deceased’s main residence was partly used for income-producing purposes such as a rental property or was not the main residence for the full period.
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.
There is a way to achieve a 50 per cent CGT discount according to the deemed date of acquisition by using 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 provides 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 per cent reduction in your capital gains,” Mr Vashisht said.
“You can also get CGT Exemption for Inherited Main Residence if it was partly used for income-producing purposes or was not the 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.
“And if 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.”
He added that the six-year absence rule for the main residence can apply, provided the beneficiary has first made the dwelling their main residence.
“However, 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,” he said.
If the property was purchased after 20 September 1985, the Legal Representatives are deemed to have inherited the asset at the cost of the deceases.
But 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, Mr Vashisht said.
“It is, therefore, important to keep proper records and obtain the cost of the acquisition of the property to the deceased,” he added.
A 50 per cent reduction in capital gains is also available if the property is retained for at least 12 months from the original date of acquisition by the deceased.
“This provides 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 per cent reduction in your capital gains,” he said.
