In its own right capital gains tax (CGT) can be incredibly complex. If you happen to be the beneficiary of a property as part of a deceased estate, you may be wondering whether you’ll need to pay CGT on the home if you choose to sell it.
To put this into perspective, we’ve broken down the tax slang from the Australian Tax Office (ATO) to explain when you may have to pay CGT on a deceased estate.
What is capital gains tax?
A capital gain in essence is the profit you make from an investment, occurring when you sell the investment and make more money from the sale than what you paid for it.
Any capital gain is reported to the ATO, added to your taxable income to the year and taxed at the rate associated with the tax bracket you fall into. CGT was first introduced on September 20, 1985 - a date you’ll see frequently throughout this article.
Your family home is typically exempt from CGT, as long as you’ve never used it to operate a business or utilised it to generate a rental income. Those distinctions are also important when it comes to deceased estates.
What is a deceased estate?
A deceased estate refers to all the property, assets, liabilities, and debts a person who has passed away holds.
Upon the person’s death, the deceased estate passes to their legal representative, who distributes it as set out in the will, or directly to their beneficiaries.
Beneficiaries are considered to have taken ownership from the date of the person’s death who bequeathed it to them.
Do you pay capital gains tax on a deceased estate?
You are not required to pay CGT on a deceased estate when it is passed to you. However, you may have to pay CGT at a later date when you sell the estate.
There are also separate rules around CGT for deceased estates regarding shares and managed funds - but here we are sticking just to property.
The ATO outlines a number of scenarios where you may be exempt from paying CGT when you inherit a property:
The deceased died before CGT introduction
If the deceased died before September 20, 1985, you are exempt from paying CGT when you sell the property.
However, any substantial renovations you make after this date may be subject to CGT.
The deceased acquired property before CGT introduction and died on or after this date
In this scenario, meeting one of two conditions will mean you’re exempt from CGT:
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Condition 1: If the dwelling was sold within two years of when you took ownership. You can also apply to extend this period if factors beyond your control prevented you from selling the property.
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Condition 2: If you do not use the home to produce income and it was the main residence of the deceased’s spouse at their time of death, a person who was permitted to live in the property as set out in the will, or a beneficiary who also disposes of the property.
The deceased acquired property on or after CGT introduction
Any capital loss or gain is disregarded when you sell the property if either of the following applies:
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You gain ownership of the property on or before 20 August 1996 and condition 2 is met (see above), and the deceased used the property as their main residence from when they bought it to when they died and didn’t gain income from it
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You gain ownership of the property after 20 August 1996 and condition 1 and 2 is met (see above), and the deceased was living in the property when they died and didn’t gain income from it.
What happens if you need to pay CGT on a deceased estate?
If you’re not exempt for CGT based on the above scenarios, you will have to pay it.
This is done by figuring out the cost base of the property. The cost base is the market value of the home when the deceased purchased it, or when they died, depending on the circumstances.
Additionally, if the property was purchased before September 21, 1999, you’ll need to use the indexation method to take into account inflation.
Read more: How to calculate capital gains tax
Tax-advantaged entities and foreign residents inheriting deceased estates
As mentioned above, you are not required to pay CGT on a deceased estate at the time it is passed to you. This is not the case for tax-advantaged entities and foreign residents.
A tax-advantaged entity is defined as a tax-exempt entity such a church or charity, or the trustee of a superannuation fund.
When these groups inherit property they are required to pay CGT if there is capital gain based on the current market value of the property.
Inheriting property from a foreign resident
Whether you pay CGT if you inherit property from a foreign resident mostly comes down to the deceased’s circumstances.
You will be exempt from CGT if you qualify for the main residence exemption. It’s important to note a person can only qualify for the main residence exemption if the foreign deceased resident passed the ‘life events test’.
To satisfy this test, you must be a foreign resident for tax purposes for a continuous period of six years or less and one of the following must have occurred:
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You, your spouse, or your child under 18, must have had a terminal medical condition
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Your spouse, or your child, must have died
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Your home must have been sold as a result of a divorce or separation.
If you acquire a property from a foreign resident, you can claim exemption from CGT provided:
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They had been a foreign resident for less than six years
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They satisfied the life events test
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Condition 1 and 2 are satisfied
It’s unlikely you will be exempt from CGT if you inherit a property a foreign resident owned for more than six years.
Record keeping
Keeping comprehensive records is extremely important when you inherit a dwelling, to ensure you don’t leave yourself open to any penalties from the ATO should they scrutinise you.
According to the ATO, you should:
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Keep a record of the market value of the property when the deceased died, and any costs you incurred from the legal personal representative.
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Have the legal personal representative value the property and give you a copy of the valuation report or have it valued yourself.
Savings.com.au’s two cents
As you can see, CGT and deceased estates are incredibly complicated.
The best course of action is likely to figure out what scenario you slot into and focus solely on that, rather than trying to understand all the ones the ATO have come up with.
At a time when you may be grieving the loss of the loved one, it may be worth consulting a finance professional to help you through this difficult period.
Article was originally published 13 November 2020 by Alex Brewster. Last updated 10 May 2022.
Image by Kelly Sikkema via Unsplash
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