In 2018, the Australian Taxation Office (ATO) issued a draft Practical Compliance Guideline (PCG) that outlined the parameters for using discretion in extending the two-year disposal period of the inherited asset for continued eligibility for full CGT exemption. This draft was solidified on 27 June 2019, introducing a “safe harbour” compliance pathway. This enables taxpayers to self-assess an extended period beyond the initial two years during which they can dispose of the property without incurring Capital Gains Tax.
The PCG elucidates guidelines on various circumstances affecting your capital gain or loss, including but not limited to whether the deceased’s main residence was used to produce income. These guidelines are aimed at assisting taxpayers and their legal personal representatives in comprehending how to accurately file their tax return concerning the inherited assets and any associated capital gain or loss.
Foreign residents or those who are not well-versed in Australian tax law are strongly advised to seek professional advice to ensure compliance and optimise potential exemptions.
Understanding the Application of CGT Rules to Inherited Property
- Ascertain the time of acquisition and the cost base of the dwelling or ownership interest for the LPR or individual beneficiary.
- Typically grant either a full or partial main residence exemption when the LPR or beneficiary ultimately decides to dispose of the dwelling or ownership interest.
Tax Alert: Restricted CGT Main Residence Exemption for Certain Foreign Residents
Particular rules are set to establish the deceased’s cost base for the inherited property and limit the availability of either a full or partial main residence exemption. These rules become notably pertinent when either the deceased or, under certain conditions, the beneficiary was an excluded foreign resident during their lifetime. For clarity, an excluded foreign resident refers to someone who has not met the Australian resident criteria for tax purposes for a period exceeding six years.
Special Rules for Acquisition and Cost Base for Inherited Property or Ownership Interest in a Dwelling
- The original date when the deceased acquired the property
- The property’s usage immediately preceding the taxpayer’s death
a) For dwellings acquired pre-CGT (before 20 September 1985) by the deceased:
- LPRs or beneficiaries are deemed to have:
- Acquired it on the death date.
- A cost base equivalent to its market value at that time.
- LPRs or beneficiaries are deemed to have:
- Acquired it on the death date.
- A cost base mirroring its market value then.
- LPRs or beneficiaries are deemed to have:
- Acquired it on the death date.
- A cost base equivalent to the deceased’s cost base at their death.
Tax Alert: Considerations for Dwellings Held as Joint Tenants
For these situations, the standard cost base rules for Legal Personal Representatives (LPRs) or beneficiaries don’t apply. There’s no market value increase. For post-CGT dwellings, such as those that were the deceased’s primary residence without generating income, the surviving joint tenant takes on a cost base equivalent to the deceased’s at their passing.
Even as a surviving joint tenant, one might still qualify for main residence benefits (like full or partial exemptions) upon property sale. Special rules view their interest as if it were inherited, allowing these benefits.
Tax Alert: Rule Changes Affecting Certain Foreign Residents
This impacts cases where the deceased was an ‘excluded foreign resident,’ having been a foreign resident for over six continuous years before their death. Consequently, the beneficiary or Legal Personal Representative (LPR) now acquires the property at the cost base value as of the date of death.
Transitional rules did exist, ignoring this foreign resident exclusion, for post-CGT dwellings bought before 9 May 2017, and sold by either the LPR or beneficiary by 30 June 2020.
Applying the full main residence exemption to an inherited asset
- The deceased acquired the property either before the capital gains tax (CGT) was instituted on 20 September 1985, or after that date, as long as it was their main residence and not used to produce income at the time of their death.
- One of the following must also be met:
- The property is sold within two years from the deceased’s death, or within an extended period approved by the Commissioner.
- The property remains the main residence of specific individuals such as the deceased’s spouse, a person entitled to live there as per the will, or a beneficiary until the property is disposed of.
A legal personal representative or individual beneficiary should be aware of these conditions to optimise tax benefits when handling inherited assets.
Tax Tip: Using the ‘Temporary Absence Rule’ for Full Exemption
- The property was the deceased’s main residence shortly before their death.
- The property was not used to produce income at that time.
Tax Alert: Special Exemption Limitations for Certain Foreign Residents
However, if the deceased was not an excluded foreign resident but the beneficiary is one at the time of the relevant CGT event (e.g., signing the contract to sell the property), the beneficiary may still be eligible for the full exemption. To qualify, they must meet either the two-year rule or the adjusted specified individual requirements, which in this case exclude the beneficiary’s residence in the property.
Partial Main Residence Exemption for Inherited Property
- Isn’t sold within two years following the death and no extension has been granted by the tax authority nor does it qualify under the new ‘safe harbour’ provisions.
- Is not the main residence of a designated ‘specified individual’ from the date of the deceased’s death until the property’s sale is finalised.
Calculating Pro-Rated Capital Gain
Pro-rated capital gain= Capital Gain × Total days Non-main residence days
To figure out the pro-rated capital gain for a Legal Personal Representative (LPR) or beneficiary, here’s how non-main residence days and total days are usually determined:
Dwelling (or ownership interest) acquired pre-CGT by the deceased
- Non-main residence days are counted from the date of death until the sale’s settlement date, during which the dwelling wasn’t the main residence of a ‘specified individual’ (like a spouse or beneficiary).
- Total days are the days elapsed from the date of death to the settlement date of the dwelling’s sale.
Understanding Pro-Rated Capital Gain for Post-CGT Acquired Dwellings
- Non-main residence days include days when the property wasn’t the main residence of either the deceased, during their ownership, or a ‘specified individual’ from the date of death to the sale’s settlement.
- Total days count from the deceased’s acquisition date to the sale’s settlement date.
Special Rules Affecting Calculations:
- If more favorable, the formula can be modified for post-CGT properties by excluding ‘non-main residence days’ and ‘total days’ after death if the property is sold within two years of death (or a longer Commissioner-approved period or under ‘safe harbour’ rules).
- For ownership interest acquired post-7:30 pm on 20 August 1996, the formula excludes ‘non-main residence days’ prior to death, provided the property was the deceased’s main residence and not income-generating right before death.
- If the deceased inherited the property from another deceased estate (i.e., acquired the property as a beneficiary after 20 September 1985), further adjustments to the pro-rated capital gain formula are necessary.
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