The role of the main residence and Capital Gains Tax in deceased estates

Often in deceased estates, the main residence comprises a substantial part of the estate’s assets. It is important that advisers understand the consequences that arise from a main residence to ensure that it is dealt with in a tax effective manner. This article will explore the CGT consequences of main residence and death.

General rule

The general rule with respect to CGT and death is that death is not to be taken as a CGT event. It should be tax neutral. With respect to main residence, an exemption on any CGT applies, although there a number of important factors to take into account.

First, there must be a dwelling. It is important to note that dwelling has been interpreted to have a broader meaning than just a house on land, and this term can apply to a caravan or a houseboat that is used as a main residence. Apartments, cottages and units are also included.

Secondly, the exemption applies to the disposal of an ‘ownership interest’. In many cases, ownership interest is evidenced by having the name stated on the title and is a simple matter. However, the actual definition of ownership interest is much broader. It could include any gain that would arise from having a long term lease, licence to occupy or other occupational right. Whilst these types of rights are less common with respect to a main residence, they do sometimes apply. Accordingly, the fact that someone lives in a house and is not noted as the owner on the title does not necessarily preclude them from having an exemption from any gain that may arise on the disposal of their ownership interest.

Thirdly, the deceased is able to be absent from the dwelling and still have it treated as a main residence for CGT purposes. Examples of where this might apply is if the deceased is travelling, or more commonly, has moved into retirement accommodation and has not yet sold the dwelling. A person can be absent from the main residence for a period of up to six years.

With these general rules considered, we now look at the special rules which apply depending on whether the dwelling was acquired pre or post CGT.

Post CGT dwelling

If the deceased acquired the property after 20 September 1985, the capital gain or capital loss is disregarded if it was the deceased's main residence just before the date of death, it was not being used at the time for income producing purposes and:

  • the trustee of the deceased estate (Trustee) or beneficiary sells the property within two years of the person's death (regardless of whether the property was the beneficiary's main residence or not); or
  • from the time the Trustee or beneficiary received an interest in the property, the property was not used for income producing purposes and it was the main residence of:
  • the spouse of the deceased (providing they were not permanently separated)
  • a person who has a right to occupy the house under the deceased's Will; or
  • the beneficiary who is disposing of the house.

Pre CGT dwelling

If the deceased acquired a dwelling before 20 September 1985, the capital gain or capital loss is disregarded if:

  • the Trustee or beneficiary sells the property within two years of the person's death (regardless of whether the property was the beneficiary's main residence or not); or
  • from the time the Trustee/beneficiary received an interest in the property, the property was not used for income producing purposes and it was the main residence of:
    • the spouse of the deceased (providing they were not permanently separated)
    • a person who has a right to occupy the house under the deceased's Will; or
    • the beneficiary who is disposing of the house.

In summary, the primary difference between pre and post CGT is the use of the dwelling – for a pre CGT dwelling, there is no need to investigate whether it was the main residence of the deceased.

Partial exemption

In situations where the requirements for a full exemption are not satisfied, it is possible that a partial exemption may be obtained. The partial exemption looks at the number of days the dwelling was used as a main residence divided by the number of days the dwelling was owned.

An example of a partial exemption is a property that was initially acquired as an investment. After three years of ownership, the owner moves in and treats it as his main residence. He later dies, having owned the property for nine years. A percentage discount will apply on any capital gain, which is worked out by dividing the number of days in six years by the number of days in nine years (leap years must be taken into account).

Testamentary Trusts

The ATO considers the ‘passing’ of an asset from an executor to the trustee of a testamentary trust to be exempt from CGT. In addition, with respect to main residence exemption and testamentary trusts, the ATO considers in ATO ID 2006/34 that the term ‘trustee of a deceased estate’ includes the trustee of a testamentary trust. As such, the trustee of a testamentary trust that disposes of a main residence is also entitled to the main residence exemption provided that the rules for pre and post CGT dwellings are satisfied.

Life interests

Whether the main residence exemption applies to life interests and remainder interests depends on the precise wording of the will. Life interests usually give rise to E events which may not be subject to an exemption (exemptions only applies to certain CGT events, not to all of them). As they are examined on a case by case basis, we have not covered them in this article.

Conclusion

There are more than 15 pages of law dealing with the main residence exemption, and numerous professional papers on the subject. As this article has shown, the issue of CGT, main residence and death is not as simple as ‘sell within two years.’ A detailed look into when the dwelling was acquired, what it was used for and when it was sold is needed to ensure that the exemption is applied, whether in whole or part.

Mellor Olsson have an experienced tax team who can advise on these issues. Please contact Peter Bosco on 08 8414 3549 or pbosco@mellorolsson.com.au for more information.

Practice Area: Tax, Revenue & Superannuation , Wills & Estates

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