Contributed by Roelof van der Merwe, National Tax Director, and Bernard Mackinnon, Senior Consultant — Tax Advisory, Findex
You may have heard of the phrase “nothing is as certain as death and taxes”. This phrase also begs the question of what the consequences will be when death and taxes collide. For example, what will the tax position be if a beneficiary of a deceased estate inherits a dwelling that was used as a main residence by the deceased?
- Will such a beneficiary qualify for the full main residence exemption (ie also for the period during which the deceased used the dwelling as a main residence) on the eventual sale of the property?
- If such a beneficiary does not qualify for the full main residence exemption, will such a beneficiary qualify for the partial main residence exemption?
As always, the answer depends on the specific facts of the case.
To help you digest the information contained in this tax snapshot (it is death and taxes after all), we are illustrating the possible scenario’s by using a simple example set out below.
- Mother acquired the dwelling for $200,000 on 1 July 1999 and used it as her main residence (without ever renting it out) up to her date of death (1 July 2009).
- The mother’s son inherited the dwelling when the mother died and at that date the market value of the dwelling was $300,000.
- The dwelling was never used as the son’s main residence, or by a surviving spouse of his mother, and no one else had an occupancy right under the will1.
- The son sold the dwelling on 1 July 2019 for $400,000.
Those are the basic facts. Now let’s examine various scenarios.
Will the son qualify for the full main residence exemption on the 1 July 2019 sale?
Based on the facts set out above, the son would not qualify for the full main residence exemption.
A beneficiary who inherits a dwelling used as a main residence by the deceased, will only qualify for the full main residence exemption2 on the sale of such a dwelling if the dwelling was acquired by the deceased:
- before 20 September 1985 (ie pre-CGT assets),or
- on or after 20 September 1985 (ie post-CGT assets), and it was the deceased’s main residence at the date of death, and also was not used for income producing purposes at that time,
and the dwelling was disposed of:
- within two years of the deceased’s death (regardless of whether the dwelling was used as a main residence after the deceased’s death), or
- at any time, provided the dwelling was occupied as a main residence by a surviving spouse, the beneficiary or a person with a right to occupy the dwelling under the will.
Because the son did not dispose of the dwelling within two years of his mother’s death, and the dwelling was never used as a main residence after her death, the son would therefore not qualify for the full main residence exemption on the eventual sale of the dwelling after holding it for 10 years.
We will now examine whether the son can qualify for the partial main residence exemption.
Will the son qualify for the partial main residence exemption on the 1 July 2019 sale?
For a post-CGT main residence that’s sold by the beneficiary more than two years after the date of death, or sold after the dwelling was never used as a main residence from the date of death, we often expect a negative tax outcome (ie a substantial capital gain on the sale of such a dwelling).
But there can be a good result if, just before the date of death, it was the deceased’s main residence and it wasn’t being used to produce assessable income.
In such a case, there will be two tax advantages:
- there will be a step-up in cost base to market value which means that the amount of capital gain will only be calculated from the time of the deceased’s death (a good result for the beneficiary because a most likely higher cost base will result in a smaller capital gain). So, instead of the son starting with a capital gain of $200,000 ($400,000 minus $200,000 cost base at the date of death), the capital gain would only be $100,000 ($400,000 minus $300,000 market value at the date of death),3 and
- in addition, there is a partial exemption that picks up the deceased’s period of main residence.4 The son’s taxable gain would therefore be reduced to $50,000 (10 years/20 years x $100,000 capital gain).
This means the son would benefit from both the market value uplift and his mother’s use of the dwelling as her main residence.
The son’s gain will then further be reduced by the 50% CGT discount (for assets held for 12 months or more), resulting in an ultimate taxable gain of only $25,000.
|1The dwelling was also never used for producing income.|
2s 118-195 of the ITAA 1997.
3Item 3 of table in s 128-15(4) of the ITAA 1997.
4s 118-200 of the ITAA 1997.
[This article was originally published in CCH Tax Week on 16 August 2019. Tax Week is included in various tax subscription services such as The Australian Federal Tax Reporter and CCH iKnow. CCH Tax Week is available for subscription in its own right. This article is an example of many practitioner articles published in Tax Week.]