How to Avoid Capital Gains Tax on Inherited Property in Australia: Expert Strategies Revealed

Dealing with property inheritance is tough, especially when it comes at a time when you’re already experiencing a loss. It’s a tricky journey with lots of red tape, and tax talk is probably the last thing you want to be juggling.

But like it or not, it’s pretty crucial to get your head around capital gains tax (CGT), especially if you want to avoid unnecessarily paying it if you eventually decide to sell the inherited property.

When you inherit Australian residential property, understanding the implications for CGT is essential, particularly with recent changes affecting foreign residents and their entitlement to the main residence exemption.

So, despite the circumstances, knowing how to manoeuvre through these taxing laws can be advantageous, finding pathways that could limit your CGT liabilities.

This blog aims to demystify the Australian CGT rules on inherited properties, offering clarity and peace of mind in a challenging time.

Understanding Capital Gains Tax On An Inherited Property & Assets

Capital Gains Tax (CGT) is a type of tax that the Australian Taxation Office (ATO) levies on the profit made from selling or disposing of an asset, including property, shares, or investment bonds.

It’s not a separate tax but a part of your income tax.

Here’s some things to consider if you sell an investment property and have to deal with CGT.

Capital Gains Tax Implications For Inherited Property

Now, let’s say you’ve inherited a property or a deceased estate. Will you have to pay CGT when you acquire it? What about if you decide to sell? Let’s find out.

A Legal Personal Representative (LPR) plays a crucial role in CGT calculations for inherited property. They are responsible for determining pro-rated capital gain for the period between the deceased’s date of death and the date of settlement when the property is sold.

The LPR must:

• Obtain a market valuation of the property as of the date of the deceased’s death. This valuation establishes the cost base for the beneficiaries inheriting the property.
• Calculate the capital gain or loss when the property is eventually sold by comparing the sale proceeds to the cost base established at the date of death.
• Determine the pro-rated capital gain attributable to the period between the date of death and the date of settlement. This is done by allocating the total capital gain based on the number of days the property was held during this period.
• Include the pro-rated capital gain in the deceased estate’s tax return for the period from the date of death to the date of settlement.
• Ensure that the remaining capital gain (for the period after the date of settlement) is correctly attributed to the beneficiaries who inherited the property, based on their respective ownership interests.

Do You Pay Capital Gains Tax On a Deceased Estate In Australia?

As a beneficiary inheriting property in Australia, you generally don’t have any CGT liability when you inherit the property. CGT is only triggered when a ‘CGT event’ occurs, such as selling or transferring the property.

However, special rules apply regarding CGT exemptions and the main residence exemption if you are a foreign resident. These rules can impose restrictions and limitations on the CGT benefits available to foreign residents.

Will the Beneficiary Have to Pay CGT if they Sell the Inherited Property?

When you decide to sell the inherited property, you might be required to pay CGT based on the property value increase since the original owner’s death date.

If the inherited property was the deceased person’s main residence, you might be eligible for the main residence exemption. This exemption can apply as a full or partial exemption, depending on factors such as rental income, the date of acquisition, non-resident status, and specific ATO guidelines.

To calculate your CGT liability, you need to subtract the property’s cost base from its selling price. The cost base typically includes the property’s market value at the time of the original owner’s death plus any associated costs (e.g., legal fees, stamp duty).

You should make sure that the cost base accounts for all original acquisition costs and any capital improvements that the previous owner made – because the higher your cost base, the smaller your gain will be. And the smaller your gain, the less tax you’ll have to pay.

However, the ATO allows for some exemptions that allow you to avoid capital gains tax on your inherited property.

CGT on Inherited Property: What Happens if You Inherited the Property Before 20 September 1985?

There’s good news if you inherited the property before September 20, 1985! In this case, you’re exempt from CGT on inherited property. This rule applies because CGT was only introduced in Australia on that date. 

However, if you make any significant improvements to the property after September 20, 1985, you might be liable for CGT on the increased value of the property due to those improvements when you eventually sell or transfer the property.

Strategies to Avoid Capital Gains Tax: Two-Year Rule for CGT

According to the two-year rule, if you dispose of an inherited property within two years from the inheritance date, you could avoid CGT regardless of how you choose to use the property.

Partial exemptions, such as the partial main residence exemption, can be applied in various scenarios. For instance, if the main residence was used partly for income-producing purposes or when an individual beneficiary inherits a property used both as a main residence and as an investment property, specific rules and limitations may apply.

For example, even if you decide to rent the property out to generate some income while you decide what to do with it (i.e., sell it or keep it), as long as you sell it within the two-year window, you won’t have to pay CGT.

In some cases, you might be eligible for an extension of the two-year time limit. Consider seeking professional advice for your specific situation if you need to request an extension for the deadline.

What if I Don’t Qualify for an Exemption?

In cases where you don’t sell the property within the two-year window and the previous owner chose to produce income from the property (i.e. it wasn’t the deceased’s main residence), either at some point during their period of ownership or right before their death, you might still qualify for a partial exemption.

Essentially, the ATO will only require you to pay capital gains tax on the period where the property was rented out (i.e., non-residence days).

A capital gains valuation will tell you exactly how much CGT you’d be liable for.

Key Takeaways

• Dealing with an inheritance can be challenging, especially when facing potential Capital Gains Tax (CGT) implications on inherited property assets.
• CGT is levied on the profit made from selling or disposing of an asset like an inherited property. Understanding how CGT works can help you mitigate any potential tax burdens.
• There are strategies to limit your CGT liabilities when selling an inherited property, such as understanding and utilising tax exemptions and concessions.
• If the inherited property was obtained before September 20, 1985, or sold within two years of inheritance, you could avoid CGT.
• In certain scenarios, a partial CGT exemption could apply if the property was used to generate income at some point.

Given these laws’ complexity and potential impact, it’s always advisable to seek professional advice to navigate these rules effectively and legally.

And if you need to get your hands on either a capital gains reduction report or a capital gains tax property valuation report , get a quote from Duo Tax today. 

FAQs

Here are the rewritten FAQs about capital gains tax on inherited property in Australia:

How is capital gains tax (CGT) calculated on an inherited property in Australia? 

When you sell an inherited property, you may owe CGT on the increase in the property’s value since the original owner’s death. To calculate your CGT, subtract the property’s cost base (market value at death plus costs like legal fees) from the sale price. Including all acquisition costs and improvements in the cost base can minimise your capital gain and tax owed.

What is the 2-year rule for inherited property from a deceased estate?

If you sell an inherited property within two years of the person’s death, it’s exempt from CGT if either: 

1) The deceased acquired it before September 20, 1985, or 

2) The deceased acquired it on or after that date, and after August 20, 1996, it was their main residence not used to produce income just before death. The ATO can extend these two years up to 18 months if the sale is delayed by exceptional circumstances outside your control.

What happens when you inherit a house in Australia? 

Inheriting a house doesn’t trigger CGT, but selling it later does unless an exemption applies. The cost base is reset to the market value at the date of death, which often reduces the capital gain when you eventually sell. Using the house as your main residence can provide a full or partial CGT exemption.

How do you calculate the cost base of inherited property in Australia? 

The cost base depends on when the deceased acquired the property:

• If acquired before September 20, 1985, it’s the market value at the date of death.
• If acquired on or after that date, it’s the deceased’s original cost base, including the purchase price and any capital improvements.

Can siblings force the sale of jointly inherited property in Australia? 

If siblings jointly inherit a property and disagree about selling, the sibling who wants to sell can bring a partition action to court to force the sale and recoup their share of the property value. The court can order the sale and division of proceeds, even if some siblings want to keep the property.

How can you avoid or minimise capital gains tax when selling an inherited property in Australia? 

You can avoid CGT by selling the inherited property within 2 years of the person’s death, if it was acquired by the deceased before September 20, 1985, or if their main residence was acquired after that date. You can also get a full or partial CGT exemption by using the inherited property as your own main residence.