Capital gains tax on deceased estate property and inherited property

Tax and estate laws can be a complex combination, but you won’t usually pay capital gains tax at the point when you inherit a property through a deceased estate. It’s only if you later sell the property that capital gains tax may apply.

The death of a loved one can be a stressful and difficult time, including when it comes to matters involving their will and estate.

If you have inherited property as part of a deceased estate, you may be wondering whether you’ll need to pay capital gains tax (CGT) on the home if you choose to sell it.

This article aims to provide a general overview of when the Australian Taxation Office (ATO) says CGT may – and may not – be payable on deceased estate property. However, this can be a complex topic, so it may be a good idea to seek professional advice on matters concerning a deceased estate in your particular circumstances.

What is capital gains tax (CGT)?

CGT is tax payable when you sell a ‘capital asset’, such as shares or real estate, according to the ATO. It can be confusing because CGT is not a separate type of tax. The way CGT works is that any taxable capital gains (or losses) you make from selling an asset are added to your assessable income (this includes your wage or salary) in the financial year you sell it.  This adjusts your income upwards in the case of a gain, and tax is then applied at normal individual income tax rates.

Not all assets are subject to CGT. The ATO specifies that only assets you acquired on or after 20 September 1985 (when CGT was introduced) are subject to CGT. Some assets are exempt from CGT altogether. Most notably, this includes the home you live in, your car or motorbike and personal belongings that cost less than $10,000.

You need to report any capital gain or loss you make in a given financial year when you complete your tax return.

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What is a deceased estate?

A ‘deceased estate’ is the name for all the property and assets belonging to a person who has passed away. When a person dies, the assets that form their estate, such as real estate, shares and belongings, may pass directly to their beneficiaries or to their legal representative (such as an executor), or from their legal personal representative to their beneficiaries.

If you’re the beneficiary of a property as part of a deceased estate, you are considered as having taken ownership of the property on the date of the person’s death. According to the ATO, other inherited assets are generally subject to CGT. However, there are special rules regarding dwellings, especially properties which were the main residence of the deceased person.

Deceased estate 3-year rule

As the ATO points out, there are no inheritance or estate taxes in Australia. However, finalising a deceased estate can take time – typically between six and 12 months, but possibly longer.

During this time income may still flow to the deceased person’s estate; for example, dividends may be paid on shares. This income needs to be reported to the ATO, and where this is the case, the estate is treated as a trust for tax purposes.

Under the deceased estate 3-year rule, a trust tax return needs to be lodged with the ATO for the first three income years if:

• the net income of the estate is above the tax-free threshold for individuals, or
• a beneficiary of the estate is entitled to receive income from the estate at the end of the financial year, or
• a beneficiary is a non-resident.

For any subsequent years, a trust tax return needs to be lodged with the ATO if the deceased estate earns any income (including capital gains).

Do you pay capital gains tax on deceased estate property, and if so, when?

The ATO spells out that if you inherit a property and later sell it, you may be exempt from paying CGT. As this is a complex area, let’s take a closer look at how it works.

First up, you won’t normally pay CGT when you inherit the property. CGT only applies (if at all) if you later sell the place.

A number of factors can shape whether you will be required to pay CGT on inherited property that you later sell (or whether you are exempt or partly exempt).

If the person you inherited the property from died before CGT started on 20 September 1985, the property is fully exempt. However, any major improvements (such as a renovation) you made to it on or after this date may be taxable, according to the ATO.

If the deceased person acquired the dwelling before 20 September 1985 but died on or after 20 September 1985, CGT does not apply, providing one of the following requirements is met:

• Condition 1: You sell the property within two years of the person’s death (meaning it is sold under a contract and settlement occurs within two years). This applies whether or not you live in the property as your main residence or use it to earn an income during this time. You can also apply to have this two-year period extended if the delay in you selling the home is due to circumstances beyond your control.
• Condition 2: From the time of the deceased’s death until you dispose of your ownership interest (such as by selling the property), the property is not used to produce an income (such as renting the property out) and is instead used as the main residence of either the spouse of the deceased when they died, another person with the right to occupy the home under the deceased’s will, or you as a beneficiary.

If the deceased person acquired the dwelling on or after 20 September 1985 and the dwelling passed to you on or before 20 August 1996, you may be exempt from CGT provided you meet Condition 2 above, and the deceased also used it as their main residence from the date they acquired it until their death and did not use it to produce an income.

If the deceased acquired the dwelling on or after 20 September 1985 and the dwelling passed to you after 20 August 1996, you may be exempt from CGT if you meet either Condition 1 or Condition 2 above, so long as the deceased was using it as their main residence and not to produce income just before they died.

If the property has been used to produce an income – for example, it was a rental property, or was not the deceased’s main residence, the ATO says CGT may be payable on some or all of the capital gain.

If you are not exempt from CGT, the ATO says you will need to know the cost base of the property. This is the market value of the property when the deceased acquired it – or when they died, depending on your circumstances. This value will be used to calculate your capital gain.

What if I inherit an interest in a property when my partner or joint tenant dies?

When you own a property with another person who passes away, how their share of the property is transferred is based on the co-ownership arrangement, according to the ATO.

It states that if a tenant in common dies, their share of the property is considered part of their deceased estate and can be either transferred to a beneficiary or sold.

If a joint tenant dies, on the other hand, their interest in the asset is acquired by the surviving joint tenant or joint tenants on the date of their death and is not considered part of the deceased estate. The ATO says if you are a joint tenant of a property you and the deceased both lived in and you continued to use it as your main residence after they died, you’ll generally be exempt from CGT.

What records and documents do I need to keep?

As with any financial or legal matter, it’s important to keep any documents and records related to the deceased estate or the property you have inherited, to ensure your liabilities and/or entitlements are calculated correctly – and you can prove this should the ATO ask for evidence.

Your legal rep or accountant can advise on the documents you need to have in your particular circumstances. As a rule though, it is a good idea to keep a copy of the valuation, showing the market value of the asset on the date the deceased died, plus records of any relevant costs incurred by you or the previous owner, such as fees associated with your legal personal representative.

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Earlier reporting by Emily Boyd.

Cover image source: Andrey Popov/Shutterstock.com.