Navigating Capital Gains Tax On Inherited Assets

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Inheriting an asset, whether it be shares, property, or a car, can be a significant financial event. It comes with both opportunities and responsibilities to navigate.

Understanding the implications of Capital Gains Tax (CGT) is important when deciding what to do with an inheritance. The inheritance itself is not classified as a triggering event; it is only if you sell or transfer ownership of the asset that CGT is triggered.

This blog aims to demystify CGT on inherited assets and provide strategies to limit your tax liability, ensuring you make the most of your inheritance.

Understanding CGT on Inherited Assets

CGT is the tax on the profit made from selling an asset that has increased in value. It’s important to note that the tax isn’t applied to the asset itself but to the gain you realise upon selling it.

The ATO considers property, shares, collectables over $500 and personal assets (furniture, household items, electric goods) over $10,000 as taxable assets. Intangible assets such as licences and goodwill may be subject to CGT.

Capital gain or loss is the difference between the sale price and the cost base. The difference can come from changed market value, renovations or invested value.

Ensure you include all original acquisition costs and improvements made by the previous owner in the cost base. This will increase the asset’s value received and reduce the gain realised, limiting the tax required.

Transferring an asset to a beneficiary is still a CGT event; however, gifting to a spouse or child can sometimes reduce the overall tax liability; let’s explore more CGT-limiting strategies below.

How is CGT Calculated on Inherited Assets?

The calculation of CGT on inherited assets depends on when the asset was initially acquired by the deceased. The Australian Taxation Office (ATO) divides assets into two categories:

  1. Pre-CGT assets (inherited before 20 September 1985):
    These assets are generally exempt from CGT.
  2. Post-CGT assets (inherited on or after 20 September 1985):
    These assets are subject to CGT.

For post-CGT assets, the cost base for calculating CGT is usually the asset’s market value at the date of the deceased’s death, not what the deceased originally paid for it. When you sell the asset, the difference between the sale price and this market value is your capital gain or loss.

Strategies to Limit CGT Liability

Hold onto the Asset for 12 months

If you inherit a post-CGT asset and sell it immediately, you’ll likely incur CGT on any gains. However, if you hold onto the asset for over 12 months, you may be eligible for the 50% CGT discount for Australian resident individuals and trusts. This can significantly reduce your tax liability.

Use the Main Residence Exemption

If you inherit a property that was the main residence of the deceased, the property may be exempt from CGT.

Please note a property can be declared the main residence of an individual even if they have been moved into a care facility as long as the property is not used to produce income. This includes operating a business from the residence.

It may also be classified as a main residence if the deceased’s spouse occupies it. This person can occupy the property under the will or you as the beneficiary.

So, if a parent passes and leaves their property to a child, and the parent’s spouse stays in the residence until the child decides to sell it, it will be exempt from CGT.

Consider the Two-Year Window for Property

Timing can be crucial in managing CGT. The two-year rule states that a principal residence property sold within the first two years of being inherited will be exempt from CGT no matter how the asset was used during those two years.

For example, you could rent out the apartment you inherited to generate income, and if you sell it within those first two years, you will not have to pay CGT on any profit gained. Unfortunately, this only applies if the original owner claimed the property as their primary residence; otherwise, it does not qualify for CGT exemption no matter the timing of sale.

You can also apply for an extension of the 2-year period if circumstances outside your control delay the disposal of the property.

In some circumstances, the extension will be applied automatically. They are:

  • the required extension is no more than 18 months.
  • the sale was completed (settled) within 12 months of the property being listed for sale
  • during the first 2 years after the deceased’s death, more than 12 months were spent addressing one of the following situations:
    • the ownership of the property or the will is challenged
    • a life interest or other equitable interest given in the will delays the disposal of the property
    • the complexity of the deceased estate delays completion of its administration
    • settlement of the contract of sale of the property is delayed or falls through for reasons outside your control

Calculate Any Partial Exemptions

If your inherited property is only partially exempt from CGT, you will need to work out the proportion of your property that is exempt.

This occurs if the property is used as a main residence for a time before it is used to generate income and sold after the 2-year window.

Keep meticulous records of any improvements made, as these costs can be added to the cost base, reducing the capital gain when you sell it.

Then, work out the taxable portion of your capital gain or loss:

  1. Calculate your capital gain or loss from selling or disposing of the property.
  2. Multiply the amount at step 1 by the number of non-main residence days.
  3. Divide the amount at step 2 by the total days.

You can use the ATO’s days calculator to determine the number of days between dates.

Consider Current Value and Timing

Collectables and personal assets’ value change according to the market. Timing the asset’s sale to an anticipated market dip might result in a lower CGT rate due to your lower marginal tax rate.

Exemptions and Special Circumstances

Deceased estate special rules:
Certain exemptions and concessions apply to inherited assets if sold as part of settling an estate or when the will states to sell the assets to leave the proceeds to a benefactor like a charity. It’s crucial to consult with a tax professional to navigate these rules.

Small business CGT concessions:
If the inherited asset is related to a small business, additional CGT concessions might be available.

Making the Most of Your Inherited Asset

Maximizing the benefit of your inherited asset while minimizing CGT takes a bit of strategic planning. Here are some steps you can take:

1. Get Professional Advice: Consult with a tax advisor or a financial planner to understand the specific tax implications of your inherited asset.

2. Understand the Asset’s Value: Have the asset appraised as close to the date of inheritance as possible to establish its market value.

3. Keep Comprehensive Records: Maintain detailed records of the asset’s cost base, including purchase details, improvements, and expenses related to its sale.

Inheriting an asset can significantly impact your financial footing. With the right strategies and professional guidance, you can navigate CGT effectively, ensuring you make the most of your inheritance. Remember, each situation is unique, and laws can change, so it’s crucial to stay informed and seek tailored advice.

Rispin Group is here to help you understand your obligations and opportunities regarding inherited assets and CGT. Contact us to provide the guidance you need to navigate these complex waters and help you achieve the best possible outcome from your inheritance.

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