Estate planning is more than just drafting a will. It’s about making thoughtful decisions today that shape the financial outcomes for your loved ones tomorrow. One area where this is especially true is the capital gains tax (CGT) treatment of inherited property.
Why CGT Matters in Estate Planning
When a property is inherited, the CGT implications can vary significantly depending on how the property was used by the deceased and how it is used by the beneficiaries. The main residence exemption plays a pivotal role in determining whether a capital gain will be taxed when the property is eventually sold.
Key Factors That Influence CGT Outcomes
- Was the property the deceased’s main residence at the time of death?
- Was the property producing income (e.g. rented out)?
- How is the property used by the beneficiaries post-death?
- Is the property sold within two years of the deceased’s passing?
These factors determine whether the cost base of the property is reset to market value at the time of death or remains at the original cost base, which can significantly affect future CGT liability.
Example: Property Planning
Consider a scenario where Mum and Dad own a coastal holiday home. As they prepare to downsize from their long-time family residence, they’re searching for a townhouse in the CBD to stay connected with their grandchildren. While their family ties will keep them visiting the city regularly, they’re considering making the coastal property their principal place of residence—embracing a sea change for retirement—while using the CBD townhouse as a convenient base when visiting loved ones.
If the coastal home is the deceased’s principal residence and not income-producing at the time of death, the cost base for CGT purposes is reset to market value. This can lead to a more favourable CGT outcome for the beneficiaries if the property is sold later, provided the arrangement reflects genuine lifestyle and residency choices.
On the flip side, if the property is rented out or not the principal residence at death, the cost base remains the original purchase price plus any improvements and holding costs. This scenario could result in a much larger capital gain on sale where the property was originally purchased by the family post the introduction of CGT in September 1985.
Applying the Main Residence Exemption
The main residence exemption under Subdivision 118-B of the Income Tax Assessment Act 1997 can eliminate CGT on the sale of a property. For inherited properties, the exemption may apply if:
- The property was the deceased’s main residence and not income-producing at death.
- The property is sold within two years of death.
- A beneficiary or someone with a right to occupy under the will uses the property as their main residence post-death.
If these conditions aren’t met, a partial exemption may apply, and CGT will be calculated based on the proportion of time the property was used to produce income or was not a main residence.
Practical Steps to Establish a Main Residence
To support a claim that a property is your main residence, the ATO considers several indicators:
- Daily occupation and use of the property.
- Keeping personal belongings there.
- Using the address for mail, electoral roll, and utilities.
- Demonstrating intent to treat it as your home.
Only one property can be treated as your main residence at a time, so if you designate the coastal home as your principal residence, your other property (eg. your downsized CBD home) becomes a CGT asset subject to capital gains tax on the eventual sale.
So where is the benefit in this scenario? In most instances, properties purchased and held by families over a longer period of time will have greater capital gains associated with their sale compared to properties purchased in today’s market. This means that understanding how the capital gains tax rules apply—particularly around the main residence exemption and cost base adjustments—can help families make informed decisions that align with their long-term intentions.
Record Keeping Is Critical
If the property was acquired before 20 September 1985 (pre-CGT), and inherited later, the cost base is generally the market value at the date of death. If improvements or subdivisions occurred later, these costs must be apportioned and added to the cost base.
Beneficiaries should keep detailed records of:
- Acquisition costs.
- Subdivision and construction expenses.
- Holding costs (rates, maintenance, capital improvements).
- Rental periods and income-producing use.
This documentation is essential for accurate CGT calculations upon future sale.
Estate Planning Is More Than Tax
The decisions made by this family may reduce the CGT impact on the eventual sale of the coastal property, however, estate planning is not just about tax or more importantly, tax avoidance. The ATO provides guidance on how exemptions and concessions apply, and when used appropriately, these exemptions can support smoother transitions of wealth and reduce unnecessary tax burdens for beneficiaries.
Ultimately, estate planning is about aligning your financial decisions with your personal goals and ensuring your legacy is passed on in the most effective way possible. It’s about protecting your assets, ensuring control of your financial structures is transferred appropriately, and passing wealth to the right beneficiaries.
It should include reviewing superannuation and insurance nominations, establishing relevant powers of attorney to safeguard decision-making in the future and aligning succession clauses within any structures to reflect the intentions of your will.
With the right advice and planning, estate strategies can be tailored to reflect your intentions and provide clarity, confidence, and financial security for generations to come.
Note – Tax outcomes can vary depending on individual circumstances. This article is for general information only and does not constitute tax advice. Individuals should seek professional advice and refer to current ATO guidance before making decisions about property use, ownership, or estate planning.
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