Property inheritance is the transfer of property to an heir or beneficiary upon the death of an owner. There are various tax implications triggered when inheriting an investment property, particularly where capital gains tax (CGT) is concerned.
In the instance that an inherited property is sold immediately, the tax implications will be determined by factors around the date of acquisition and the type of use of the property by the previous owner from whom it was inherited.
In this article BMT outlines the CGT implications of four different scenarios including:
- inheriting a property that was a main residence and selling it immediately
- inheriting an investment property and selling it immediately
- inheriting an investment property and living in
- inheriting an investment property and keeping it as an investment property
Scenario 1: Inheriting a property that was a main residence and selling it immediately
Let’s say that a beneficiary has inherited a property from a deceased family member and decides to sell the property rather than keep it. Will capital gains tax apply? Well, that will depend on the purpose of the property and the date the deceased acquired the property.
The property will be exempt from CGT if:
• the property was the main dwelling (i.e., was not used to produce income) from the time the deceased acquired the property until their death, and is sold by the beneficiary within two years
• from the time the deceased died, the property was used only as the main residence of at least one of the following people:
– the spouse of the deceased immediately before their death (but not a spouse who was permanently separated from the deceased)
– a person who has a right to occupy the property under the deceased’s will
– the beneficiary, if they dispose of the property as a beneficiary.
If the property was used to produce income, i.e., it was an investment property, the property is not fully exempt. However, the beneficiary could qualify for a partial exemption.
Scenario 2: Inheriting an investment property and selling it immediately
Let’s now say a beneficiary has inherited a property which was used to produce an income – and never as a main residence. In this scenario the full CGT applies when selling.
But if the inherited property was used as both a main residence and as an investment property, then a partial CGT exemption may apply.
The partial exemption is calculated as follows:
Capital gain (A) × non-main residence days (B) ÷ total days (C) = capital gain or loss (D)
|ExampleSally inherited her grandmother’s rental property which she sold immediately, resulting in a capital gain of $400,000 (A). The house was owned by Sally’s grandmother for twenty years (C), twelve (B) of which was used to produce an income. Sally will need to pay CGT on the time the property was income producing but will be eligible for an exemption for the time it was a main residence and will qualify for the fifty per cent discount as it was owned for longer than twelve months.
The capital gain is calculated as follows:
The fifty per cent discount is calculated as follows:
$240,000 x 50% = $120,000
A capital gain of $120,000 is then taxed at Sally’s marginal tax rate. In instances where an inherited property was used both as a rental and a main residence, but was the deceased’s main residence right before their death and disposed of within two years, the property is exempt from CGT.
For inherited properties that were previously inherited a different tax implication applies. The formula for calculating the partial main residence exemption is adjusted if the deceased also acquired the property on or after 20 September 1985 as a beneficiary (or trustee) of a deceased estate. The main residence exemption is calculated according to the number of days the property was the main residence of the current owner and the previous beneficiaries.
It’s important to note the main residence exemption is generally not available to foreign residents or if the deceased was a foreign resident.
Scenario 3: Inheriting an investment property and living in it
There are partial CGT exemptions available to people who inherit investment properties and live in them as their main residence. A person who inherits an investment property can claim the days the property was not used to produce an income under the main residence exemption in the event of selling.
Tom inherited a property from his father (James) which James used as a rental property for eight years. Tom lived in the property for ten years after taking ownership, which makes it his main residence. He is therefore eligible for the main residence exemption. Tom decides to sell the property after ten years of living in it, resulting in a capital gain of $350,000.The main residence exemption is calculated as follows:
$350,000 × 2,920 ÷ 6,570 = $155,555
$155,555 x 50% = $77,777.50
In this scenario Tom will pay CGT on the $77,777.50 at his marginal tax rate instead of $350,000 under the main residence exemption and the fifty per cent discount.
Scenario 4: Inheriting an investment property and keeping it as an investment property
In scenarios where the new owner wants to continue using their inherited property as a rental property, a different set of tax implications and benefits apply.
If the property was used as a main residence at any stage of ownership, it may be eligible for a partial exemption. The fifty per cent CGT discount will also apply in this scenario if the property is owned for longer than twelve months. For instance, if a person continues to rent their inherited property for seven years, then decides to sell, they will be eligible for a fifty per cent discount on CGT.
In scenarios where the property was only used as a rental and never as a main residence, it will not qualify for a partial exemption but will be eligible for the fifty per cent discount if owned by the beneficiary for longer than twelve months.
Because the inherited property is income producing the new owner will be eligible to claim the tax deductions from owning an investment property including claiming the interest on mortgage payments, land tax, strata fees, insurance fees and council rates.
New owners will also be eligible to claim depreciation deductions.
Depreciation is the natural wear and tear of property and assets within it over time. Owners of income-producing properties can claim this depreciation as a tax deduction each financial year.
Capital works deductions (Division 43) are income tax deductions an investor can claim for the wear and tear that occurs to a building’s structure and items considered to be permanently fixed to the property.
Plant and equipment (Division 40) assets are items which are easily removable or mechanical in nature from a residential investment property or commercial building. Property owners can also claim depreciation for the wear and tear of eligible plant and equipment assets not considered second hand.
Unlike other tax deductions, depreciation is a non-cash deduction, this means no money needs to be spent in order to claim it. To learn more about how depreciation interacts with capital gains tax, click here.
To claim maximised and fully complaint depreciation deductions an investor should get in contact with a specialist quantity surveyor to organise a depreciation schedule.
A BMT Tax Depreciation schedule outlines every depreciable item over the life of the property (forty years) which an accountant then uses to determine the depreciation claim.
To discuss the available depreciation deductions in an inherited property call BMT on 1300 728 726 or Request a Quote.
BMT recommend consulting an accountant to work out any CGT implications to your individual scenario before making financial decisions.