Everything You Need to Know About CGT on Inherited Property
When it comes to inheritance tax, particularly the capital gains tax (CGT) on inherited property, there’s a lot to understand.
Generally, when ownership of a property is transferred to another person or entity, the transfer will trigger a capital gain or loss, regardless of whether there was a monetary exchange.
This transfer often results in significant tax implications.
But what does this mean for inherited property?
Thankfully, you won’t need to pay capital gains tax (CGT) at the time you inherit the property from a deceased estate. But there’s a strong possibility that you’ll trigger CGT liability on the sale of that inherited property.
So, here’s what you need to know about CGT on inherited property and how it differs from inheritance or estate taxes.
Do You Pay Inheritance Tax in Australia?
No, Australia doesn’t have official inheritance tax. Instead, the country abolished death duties (another term for inheritance tax) in 1979. This means that beneficiaries generally do not pay tax on assets or funds they inherit.
However, there might be other tax implications, such as capital gains tax, depending on the nature of the inherited assets and what the beneficiary decides to do with them.
What is Capital Gains Tax (CGT)?
When you sell your investment property, any profit you make is termed a capital gain and must be reported on your annual income tax return. However, according to the Australian Taxation Office (ATO), CGT isn’t a standalone tax but instead merges with your yearly income and applying your standard individual income tax rates.
So, for example, let’s say you have an annual income of $80,000. You bought an investment property in Melbourne for $500,000 and sold it a few years later for $650,0000 – making the profit, or capital gain, from this sale $150,000.
If you’ve held the property for more than 12 months, you may be eligible for the 50% CGT discount, reducing the taxable capital gain to $75,000. This $75,000 will then be added to your annual income on your tax return, making it $155,000 for that year. You’ll be taxed based on your marginal tax rate for the combined amount.
Do Beneficiaries Pay Capital Gains Tax on Inherited Property?
If you inherit property from a deceased estate, the transfer of ownership of the asset from the deceased estate to you (i.e., the inheritance transaction) isn’t considered a capital gains tax event. And if the transfer isn’t considered a CGT event, there is no capital gains tax liability.
However, if you decide to sell the property, CGT on inherited property may apply.
Paying CGT When Selling Inherited Property From Deceased Estate
According to the ATO, there are certain rules and exemptions that apply depending on whether you’re selling property that was used as a main residence (such as the main residence exemption) or property that was used as an investment to generate an income stream.
However, if you’re selling an inherited property from a deceased estate, certain special CGT rules are relevant.
Whether CGT is applicable depends on the following factors:
- When the deceased acquired the property
- How the deceased used the property while they owned it (i.e. was it the deceased’s main residence or was it used to produce income?)
- The deceased’s date of death
- Whether the deceased was an Australian citizen at the time of their death
- Whether you were an Australian resident when you sold the inherited property
CGT Exemptions When Inheriting Property
Based on the factors listed above, certain circumstances will either fully or partially exempt you from paying CGT on inherited property.
You Inherited the Property Before September 20, 1985
If the deceased died before September 20, 1985, and the property transfer also occurred before that date (i.e., the property is a pre-CGT asset), you’ll be completely exempt from capital gains tax.
However, if property underwent major capital improvements on or after that date for the purpose of using the property to generate income, part of any capital gain that’s accredited to those improvements will be taxable.
You Inherited the Property On or After September 20, 1985
If the deceased purchased the property before September 20, 1985, but you inherited it after that date, you have two years to sell the property if you want to qualify for the CGT exemption.
In other words, a two-year window allows you to be exempt from CGT if you sell the property that was the main residence of the deceased, regardless of whether you used the property as your family home (main residence) or to generate income.
Note: If you sell the inherited property after the two-year window, the full CGT exemption may still apply if the Commissioner of Taxation grants an extension.
Example:
Noah bought a property in January 2008. He treated the home as his main residence (or dwelling), and it was never used as an investment to generate income.
Unfortunately, Noah passed away suddenly in June 2019 and left the flat to his brother William.
After about 11 months of owning the property, William decided that it made financial sense to sell the property, so he put it on the market, and it sold within two months.
So after owning the property for 13 months, William disposed of the inherited property and is entitled to a full CGT exemption. This is because Noah had lived in it when he died, and William disposed of it within two years of his brother’s death.
If you don’t sell the property within that two-year window but you occupy the inherited property as your main residence, you’ll be exempt from paying CGT on your inherited property, provided that property remains your main residence for the entire time before you sell it.
Example:
Olivia purchased a property on July 3, 1984. She passed away in January 2003, and her niece, Amelia, inherited the property.
According to Olivia’s will, her husband, Jack, had the right of occupation of the property until Amelia decided to sell it. Jack moved into the property and treated it as his main residence for the entire period that he survived Olivia.
Amelia only sold the property in January 2012, after Jack had passed away.
As Jack moved into the property as soon as the administration of Olivia’s estate was granted, it was his main residence until Amelia sold it.
So, Amelia is entitled to a full main residence exemption.
Note: The ATO has put together a useful questionnaire that could help you establish whether or not you qualify for the full CGT exemption for the sale of inherited property.
Partial Capital Gain Exemption
If you don’t qualify for the two full CGT exemptions, you may be able to claim a partial exemption, but it’s dependent on how the deceased used the property before their passing.
For example, if they purchased the property after September 20, 1985, and it wasn’t considered the deceased person’s main residence just before they passed away, a partial exemption may apply.
Or, if the property was an investment and used to generate income before the deceased’s death or once you inherited it, a partial exemption may also apply.
Example:
Sophia purchased an investment property for $520,000 in September 2002. She used it as an investment to generate rental income and never lived in it as her main residence.
Sophia passed away in May 2009 and left the property to her cousin, Henry, who decided to use the inherited property as his main residence.
The property has experienced substantial growth since Sophia initially purchased it. So, Henry decided to sell the property in April 2019 for $816,000.
As the property wasn’t Sophia’s main residence just before she died, Henry can’t claim a full CGT exemption for the period that Sophia used it to generate rental income. However, Henry is entitled to a partial CGT exemption for the period that he used the house as his main residence.
To calculate the capital gain, Henry would have to work out:
- how many days Sophia used the property for rental income purposes, and
- the total number of ownership days (i.e., Henry’s and Sophia’s ownership days in total).
The formula would be as follows:
Capital gain x (non-residence days ÷ today days owned) = taxable amount.
Calculating a partial exemption is pretty complex, and there are special rules for calculating the inherited property’s cost base for tax purposes, so you’ll need to engage the services of an expert tax agent to get financial advice and see if you qualify for the partial exemption and how much the cost base and exemption amount to.
Key Takeaways
- Inheritance tax doesn’t exist in Australia, but depending on certain circumstances, you may end up paying CGT if you decide to sell property that you inherit.
- Specific CGT rules apply to your potential liability depending on various factors, including when the property was purchased, when it was inherited, and how it was used before and after inheritance.
- Those factors will also establish whether you’re eligible to claim a full or partial capital gains tax exemption.
- Identifying your eligibility for a full exemption can be complex, and calculating your partial exemption can be pretty tricky.
So, to ensure you’re meeting your CGT and other tax obligations or making the most of the available exemptions, you should seek professional advice from a tax agent who can help you navigate tax on your inheritance.
At Property Tax Specialists, we know the tax rules inside and out, so you don’t have to. We make sure your investment property portfolio complies with regulations and meets the necessary reporting obligations.
So, if you have any questions about CGT on inherited property, paid tax implications, or capital gains tax in general, get in touch today.
FAQs
Is Inheritance Taxed in Australia?
In Australia, there’s no specific “inheritance tax.” However, beneficiaries might face capital gains tax (CGT) when they sell an inherited property.
How Does Capital Gains Tax on Inherited Property Work?
If you inherit a property, you won’t pay CGT immediately. CGT may apply when you decide to sell the inherited property, depending on various factors, like when the deceased acquired the property and its use.
What Should I Know About Tax on Inheritance in Australia?
While Australia doesn’t have a direct inheritance tax, there are tax implications, especially related to capital gains, when you sell an inherited asset.
I’m Inheriting Property from My Parents in Australia. Are There Any Specific Rules?
Yes, there are specific rules regarding CGT, especially if the property was your parents’ main residence or if it was used to generate income. The date of acquisition and other factors also play a role.
How Is Capital Gains Tax Calculated for Inherited Property?
The calculation considers factors like the property’s cost base, the period it was used to generate income, and the total ownership days. It’s advisable to consult a tax specialist for precise calculations.
Is There an Australia Inheritance Tax on Assets Other Than Property?
Australia doesn’t have a specific inheritance tax. However, tax implications can arise when you dispose of or earn income from an inherited asset
What is a Super Death Benefit?
A super death benefit refers to the payment made from a deceased person’s superannuation fund to their beneficiaries or estate. This benefit can be in the form of a lump sum or an income stream. The tax treatment of a Super Death Benefit depends on various factors, including the age of the deceased at the time of death, the age of the beneficiary, and whether the benefit is paid as a lump sum or income stream.
Disclaimer
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.
