If you are an individual beneficiary or a Legal Personal Representative (LPR) who has inherited Australian residential property from a deceased estate, you may be eligible for comprehensive or partial exemption from Capital Gains Tax (CGT) under an augmented main residence exemption framework. To be eligible for this tax relief, certain conditions need to be met. For instance, selling the inherited property within two years of the deceased’s death (or within a further duration sanctioned by the Commissioner) allows the beneficiary or LPR to claim full CGT exemption.

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

Particular provisions outline how Capital Gains Tax (CGT) is applied to a property that served as the main residence of a deceased individual. When a dwelling, or an ownership interest in it, is transferred to an individual beneficiary or the Legal Personal Representative (LPR) of a deceased taxpayer’s estate, specialised rules are set into motion. These rules aim to:
  • 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.
These specific CGT provisions assist in clarifying how inherited property is to be treated for tax purposes, ensuring that beneficiaries and their LPRs are in compliance with Australian tax law while potentially benefiting from available exemptions.

Tax Alert: Restricted CGT Main Residence Exemption for Certain Foreign Residents

As of 7:30 pm on 9 May 2017, specific limitations have been placed on foreign residents, particularly those categorised as non-residents for Australian tax matters. These individuals are mostly precluded from benefiting from the Capital Gains Tax (CGT) main residence exemption. Implementing these restrictions came with certain transitional provisions. The implications of this limitation extend to Legal Personal Representatives (LPRs) and beneficiaries who inherit Australian residential property.

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

When a residential property or an ownership interest in it is passed to a Legal Personal Representative (LPR) or an individual beneficiary from a deceased taxpayer’s estate, distinct rules concerning acquisition time and cost base become applicable. These rules hinge on two essential factors:
  • The original date when the deceased acquired the property
  • The property’s usage immediately preceding the taxpayer’s death
This translates to:

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.
b) For dwellings acquired post-CGT (on/after 20 September 1985) and used as the deceased’s main residence without income-earning purposes:
  • LPRs or beneficiaries are deemed to have:
    • Acquired it on the death date.
    • A cost base mirroring its market value then.
c) For dwellings acquired post-CGT, not used as the deceased’s primary residence and/or for income generation:
  • 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.
These specialised provisions help beneficiaries and their LPRs navigate the complexities of Australian tax laws pertaining to inherited properties, ensuring they accurately establish acquisition times and cost bases.

Tax Alert: Considerations for Dwellings Held as Joint Tenants

When a deceased individual holds a dwelling as a joint tenant (not as a ‘tenant in common’), the ownership interest directly passes to the remaining joint owner(s) without navigating through the deceased’s estate.

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

The special cost base provision, which previously allowed for a market value uplift on a deceased’s post-CGT main residence not used for income, has been revoked for Capital Gains Tax (CGT) events from 7:30 pm on May 9, 2017, onward.

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

In Australian tax law, the full main residence exemption can be applied to an inherited property, eliminating any capital gain or loss when selling it. This is conditional on meeting two key criteria:
  • 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

To qualify for a full exemption from Capital Gains Tax (CGT) on a property acquired post-CGT, two conditions must be met:
  • The property was the deceased’s main residence shortly before their death.
  • The property was not used to produce income at that time.
It’s important to note the first criterion is not strictly tied to physical occupancy. The property can still qualify as the deceased’s main residence under the ‘Temporary Absence Rule,’ even if they were not residing there at the time of death.

Tax Alert: Special Exemption Limitations for Certain Foreign Residents

If the deceased was an ‘excluded foreign resident’—defined as a foreign resident for over six consecutive years—at the time of their death, the full main residence exemption from Capital Gains Tax (CGT) is not available to the Legal Personal Representative (LPR) or beneficiaries. This status overrides the usual exemption rules.

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

If the full main residence exemption is unattainable, an individual beneficiary may still be eligible for a partial exemption. This is applicable when the property, originally acquired as the deceased’s main residence:
  • 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.
In such instances where a partial exemption applies, the capital gain arising from the property’s sale by a Legal Personal Representative (LPR) or beneficiary will be pro-rated. This pro-rated capital gain will be the amount considered in calculating the beneficiary’s net capital gain for the tax year.

Calculating Pro-Rated Capital Gain

The pro-rated capital gain is calculated as follows:

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.
Essentially, this approach omits the ownership period before the deceased’s death. The main residence exemption is primarily based on the days the dwelling serves as the main residence for a ‘specified individual’ after death, provided it wasn’t used to generate income.

Understanding Pro-Rated Capital Gain for Post-CGT Acquired Dwellings

For a dwelling acquired post-CGT:
  • 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.
Essentially, the main residence exemption applies mainly to the days the property served as the main residence for both the deceased (before death) and a ‘specified individual’ (after death).

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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This outline is for general information only and not as legal, tax or accounting advice. It may not be accurate, complete or current. It is not official and not from a government institution. Always consult a qualified professional for specific advice tailored to your unique circumstances.

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