Taxation

Australia may not have death duties, but capital gains tax may be considered the equivalent. If you inherit shares or an investment property it is almost impossible to avoid paying tax at some point.

A partner and tax expert at Matthews Steer Chartered Accountants, Anthony Flapper, says the family home is one of the most common inheritances.

It is also one on which tax can be avoided.

Two-year window

If the property was the main residence of the deceased, the beneficiary inheriting the property has a two-year window in which to sell the property tax free.

But Flapper says that, despite the grace period, it is important not to leave it until the last minute to sell.

“If you sell the property one month before the two-year grace period is up, and the property has a standard 60-day settlement, then you could be liable for capital gains tax on a portion of any gain,” he says.

Before or after 1985

If an investment property or shares are inherited, the amount of tax payable at some point will partly depend on when the asset or assets were purchased.

If an asset was bought before September 20, 1985, the value at the date of death is inherited, says Bruce Christie of Centric Wealth Advisers.

That means the value of the asset at the date of death becomes the so-called cost base for calculating capital gains tax.

For example, if an investment was bought in 1984 for $2 and is worth $10 at the date of death, the beneficiaries inherit a $10 capital gains tax cost base because the deemed acquisition date is the date of death. If it is sold at $11, the realised capital gain is $1. If this investment is sold within 12 months, the assessable gain for an individual beneficiary is $1.

Investments owned for longer than 12 months become entitled to a 50 per cent discount on the capital gain. So, in this example, if the investment is sold after 12 months the assessable gain for an individual beneficiary is 50¢.

The tax rules are different for assets that were bought after September 20, 1985.

If an investment was bought in 1986 for $2 and is worth $10 at the date of death, then the beneficiary will inherit a cost base of $2.

If the investment is then sold by the beneficiary for $11, the realised gain is $9 and the assessable gain is either $9, if sold within 12 months of the date of acquisition by the beneficiary, or $4.50 if sold more than 12 months after the date of acquisition (whereby the 50 per cent discount rule would apply).

Working out the cost base

In the case of property, if your parents bought a property in 1960 for $10,000 and it passes to you and is now valued at $500,000, then the market value at the date of death becomes the cost base.

This means that no tax will be payable on the cost base of $500,000 but any future increase in value above this base will be subject to capital gains tax (provided the beneficiary does not move into the property as a main residence).

Flapper says the rules change if the property was purchased post-capital gains tax or 1985.

If your parents bought a house in 1990 for $150,000 which is then passed on to you, the cost base is the initial purchase price.

So if the property is now worth $500,000 and your cost base is $150,000, then you have a gross capital gain of $350,000. “The key thing to remember is the two-year grace period which allows you to sell an inherited property, that was the main residence of the deceased, tax free,” Flapper says.

Complications of a second property

Suzanne Haddan of BFG Financial Services says inheriting a second property – particularly a holiday home – can have additional complexities if it was bought after August 21, 1991.

If it was bought after this date, the costs of owning real estate, such as interest, rates and land taxes, may form part of the cost base to determine whether you have made a capital gain or capital loss when the property is sold.

As you may be liable for capital gains tax when the proceeds of selling exceed the cost base, it’s in your interest to work out any costs of owning the real estate. Generally, these would be expenses not previously claimed as a tax deduction. Bruce Christie says the executor of the estate may elect to sell investments within the estate before they pass to the beneficiary.

The executor is a person appointed under a will to arrange for the distribution of assets to the beneficiaries that have been selected.

Decisions taken by the executor can be made within a three-year period after death, as an estate is given up to three tax years to finalise its administration.

Assuming the value of the investment did not change, the realised value each year would be lower than selling in one year and, since an estate is taxed at marginal rates and the 50 per cent discount rule applies, the tax payable may be significantly lower than if sold by the beneficiary, Christie says.

“Other issues need to be considered, such as the additional professional fees to administer the estate, as well as the personal circumstances of the beneficiary, which may have a higher priority than tax savings.

“In all such circumstances, it is imperative to seek professional advice from a qualified accountant and licensed financial planner, to cover both the tax and investment perspectives,” he says.

Suzanne Haddan says beneficiaries often look at a share portfolio and think they’d like to hold on to some stocks, without thinking of the tax consequences.

“It might be cheaper to sell the shares within the estate and then buy them back in your own name.”