Oftentimes, a person will occupy their home until they pass away. In these instances, the dwelling can then be directed by the Will to be inherited or sold, with the proceeds from the sale being distributed in accordance with the wishes of the deceased. But what happens when a property is inherited rather than sold? Do you pay capital gains tax on inherited property? Navigating tax obligations on inherited property can be complex, but understanding the rules can help you make informed decisions. Here is some key information to help you understand what is capital gains tax on inherited property and how to avoid capital gains tax on an inherited property.
What is CGT on inherited property?
Capital Gains Tax (CGT) on inherited property in Australia applies when you sell a property that you inherited from a deceased estate. While inheritance itself is not taxed, CGT may be payable on the profit (capital gain) made when selling the property, depending on factors such as when the deceased acquired the property, how long you’ve owned it, and whether it was their primary residence.
Understanding inherited property and capital gains tax
When a property is inherited, the person inheriting the property does not pay capital gains tax on inherited property in Australia. Capital gains tax is only assessed when a property is actually sold. But, with inherited property, there are different tax rules and implications that are somewhat dependent upon when the property was purchased by the deceased and when it was inherited by the beneficiary. There are a few property caveats in NSW. For example, if the property was the deceased’s main home and sold within two years of inheritance, it is generally exempt from CGT. However, if the property was an investment or sold after the two-year period, CGT may apply. Understanding capital gains tax on inherited property exemptions, discounts, and tax implications can help beneficiaries manage their tax obligations effectively.
How joint tenants impacts capital gains tax on inherited property in NSW?
Joint tenancy significantly influences CGT implications upon the death of a co-owner. In a joint tenancy, co-owners hold equal shares of the property, and upon the death of one joint tenant, their interest automatically transfers to the surviving joint tenant(s) through the right of survivorship. This means the deceased’s share does not form part of their estate but passes directly to the surviving co-owners. If you are a joint tenant with the deceased and the property transfers to you via their Will, you will not pay capital gains tax on the inheritance of their share of the property.
For CGT purposes, the Australian Taxation Office (ATO) treats the deceased’s interest as being acquired by the surviving joint tenant(s) at the time of death. The cost base of the acquired interest depends on when the deceased originally purchased their share:
- If the deceased acquired their interest on or after 20 September 1985: The first element of the cost base for the surviving joint tenant is the deceased’s cost base on the day they died, divided by the number of joint tenants (including the deceased).
- If the deceased acquired their interest before 20 September 1985: The first element of the cost base is the market value of the deceased’s interest at the date of death, divided by the number of joint tenants (including the deceased).
Understanding the distinctions between joint tenancy and tenancy in common is crucial in property law and conveyancing, as these structures affect not only ownership rights but also tax liabilities.
Tenants in common vs. joint tenancy
Tenants in common is a type of property ownership where each owner holds a separate, distinct share of the property. Unlike joint tenancy, this form of ownership allows owners to control their share independently, which impacts inheritance, taxation, and property rights.
Key differences
Ownership Structure
- Tenants in Common: Each owner has a defined percentage of the property (e.g., 50/50, 70/30).
- Joint Tenancy: Each owner holds an equal share, regardless of financial contribution.
Inheritance & Transfer of Ownership
- Tenants in Common: When an owner dies, their share passes through their will to a beneficiary or estate.
- Joint Tenancy: Ownership automatically transfers to the surviving joint tenant(s) through the right of survivorship.
Selling or Transferring Ownership
- Tenants in Common: Owners can sell or transfer their share independently without affecting the other co-owners.
- Joint Tenancy: An owner cannot sell or transfer their share separately without dissolving the joint tenancy.
Capital Gains Tax Implications
- Tenants in Common: If the deceased’s share passes to a beneficiary who later sells the property, they may be liable for CGT and should consult a solicitor.
- Joint Tenancy: Since the share automatically transfers to the surviving owner(s), CGT may apply only when the entire property is later sold.
Understanding these differences is crucial when planning inheritance, selling property, or structuring ownership to best suit financial and legal needs.
Determination of CGT on inherited property
There are three possibilities that cover when a person who inherits a property does, or does not, pay capital gains tax upon selling said property.
Purchase and transfer of property prior to 20th September, 1985.
1) The first determining factor is the easiest of the three. If the deceased purchased the property and died prior to the beginning of the assessing of capital gains tax on 20th September, 1985 the beneficiary of the property does not pay capital gains tax should they sell the property in the future. Under these circumstances the seller of the property may only be liable for additional taxes on any major improvements made to the property after the inception of the capital gains tax law.
Purchase of property before 20th September, 1985 but death and transfer of property subsequent to 20th September, 1985.
2) The second manner in which capital gains tax can be avoided is if the person purchased the property before the capital gains tax took effect, but died after 20th September, 1985. However, to be exempt from paying capital gains tax on a property that was inherited under these conditions, requires that the beneficiary of the property meet one of two very specific conditions. Those conditions are;
a. The beneficiary of the property sells the property within two years of the death of the previous owner. This exemption applies even if the recipient of the property lived in it during this time period or rented it for income purposes or;
b. If the home was occupied from the date of death of the owner by either the spouse of the deceased, by someone else the will entitled to live in the home, or by yourself as the beneficiary of the home. For this exemption to apply, the home cannot have been used to generate any form of income.
Determining Capital Gains Tax on a Dwelling Purchased After 20th September, 1985
The next set of factors applies to a home purchased after the capital gains tax laws came into existence. This scenario is ruled by the dates of 20th September, 1985 and 20th August, 1996.
Purchase of Property on or after 20th September, 1985 but transferred via death to the beneficiary before 20th August, 1996.
Under these date rules, you can avoid capital gains tax if you meet the following;
- Condition 2(b) as noted above and
- The deceased used the home as their main residence from the date of purchase until their date of death and
- The deceased never used the property as a source of income.
Purchase of Property on or after 20th September,1985 but transferred via death to the beneficiary after 20th August, 1996.
Under these date rules, you can avoid capital gains tax if you meet the following;
- Either condition 1 or condition 2 as noted above and
- The deceased used the home as their main residence from the date of purchase until their date of death and
- The deceased never used the property as a source of income.
FAQs
Do I always have to pay CGT on inherited property?
No, you don’t always have to pay capital gains tax on inherited property in Australia. Whether CGT applies depends on factors such as how the deceased used the property, when they acquired it, and when the beneficiary sells it. If the property was the deceased’s main residence and was sold within two years of inheritance, it is generally exempt from CGT. However, if the property was an investment property or is sold after the two-year period, CGT may apply based on the increase in value since the deceased acquired it. The cost base (purchase price, legal fees, and improvements) plays a key role in determining the taxable gain. Beneficiaries should seek legal or tax advice before selling an inherited property to understand their potential CGT obligations and whether any exemptions or discounts apply.
How to avoid capital gains tax on inherited property?
To avoid or minimise capital gains tax on inherited property in NSW, beneficiaries can take advantage of exemptions and strategic planning. If the property was the deceased’s main residence and is sold within two years of inheritance, it is generally exempt from CGT. Holding the property for more than 12 months before selling may also qualify for the 50% CGT discount. Additionally, if the property is transferred to a beneficiary under a Will rather than sold, CGT may not apply until the beneficiary decides to sell. Proper record-keeping of property expenses and improvements can also help reduce taxable gains. Consulting a tax professional ensures you maximise available exemptions and avoid unexpected tax liabilities.
How does CGT work for properties used as rental income?
If an inherited property was used as a rental property, CGT will generally apply when it is sold. The taxable gain is calculated based on the difference between the sale price and the property’s cost base, which includes the original purchase price, legal fees, and any capital improvements. If the deceased purchased the property before 20 September 1985, it is exempt from CGT, but any capital gain from the time of inheritance will be taxable. Additionally, any depreciation claimed on rental income while owning the property may increase the taxable gain. To minimise CGT liabilities, seeking professional tax advice is recommended before selling a rental property and going through the settlement process.
Make informed decisions about your inherited property
If you do not meet any of the conditions described herein, you may be liable to capital gains taxes on the sale of an inherited property. As this is a legal situation that can be quite complicated, it is always highly encouraged that you speak with property lawyers in Sydney who specialise in the sale of inherited property before taking any action.
In the event that you find yourself in need of assistance, please contact the law offices of Owen Hodge Lawyers at your earliest convenience on 1800 770 780 to schedule a consultation. At Owen Hodge, we are always happy to assist clients in understanding the full ramifications of any and all of your legal needs.