Edited version of private advice

Authorisation Number: 1052277342984

Date of advice: 1 August 2024

Ruling

Subject: CGT - deceased estate - partial main residence exemption

Question 1

Are you entitled to a partial exemption for capital gains tax arising from the sale of the inherited property under section 118-200 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the Commissioner exercise the discretion under subsection 118-200(3) of the ITAA 1997 to allow an extension of time for you to dispose of your ownership interest in the dwelling.

Answer

Yes.

Question 3

Do you need to adjust the partial exemption to increase any non-main residence days due to the Deceased using the Property to produce assessable income under section 118-190 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

In XX 19XX, the deceased (the Deceased) acquired a property 'as a beneficiary of their parent's deceased (your Grandparents) estate.

The Property is less than two hectares in size.

From XX XX 19XX to XX 19XX, your Grandparents used the Property as their main residence.

From 19XX, the Property was heritage listed.

On XX XX 20XX, the Deceased passed away, and left a will (the Will).

The Property was the Deceased's main residence just before they passed away.

The Property was income producing just before the Deceased passed away, where X rooms of the Property were rented out (approximately X% of the property).

Under clause X of the Will, the Deceased gave you a life tenancy in the Property.

Provided that you, as the life tenant "undertake repairs and maintenance reasonably required to preserve the heritage categorisation of the property". The Executor of the Will reserved the right to inspect the Property to ensure that you were abiding by this.

At the time of the Deceased's death, the Property was in poor condition, including major water ingress, deteriorating masonry, cracks, poor drainage, failed guttering, chimneys, and roof.

In XX 20XX, the heritage management for the Property, listed extensive, urgent, and immediate remedial works to prevent irreversible deterioration and conserve the fabric of the building.

You were obstructed from selling the Property until you completed the remedial works.

On XX XX 20XX, the Deceased's Death Certificate was registered.

On XX XX 20XX, Probate was issued.

On XX XX 20XX, the Certificate of Title was registered in your name and your sibling's name. You and your sibling are the beneficiaries of the estate.

The Certificate of Title was delayed due to the complexity of the life tenancy clause in the Will. The remedial works could not start until you were registered as the owner on the title, to allow you to apply for a Development Application.

On XX XX 20XX, you received approval for the urgent and immediate conservation works.

On XX XX 20XX, the Certificate of Title was issued to you and your sibling.

In XX 20XX, you submitted the Development and building permit applications.

On XX XX 20XX, you signed a contract with builders.

There were delays in commencing the works due to a shortage of building supplies and labour, because of COVID-19.

On XX XX 20XX, the tenants moved out of the Property. The property then remained vacant until it was sold.

On XX XX 20XX, the conservation work began.

On XX XX 20XX, you received notice of completion.

In XX 20XX, the Property was listed for sale.

On XX XX 20XX, you entered a Contract of Sale.

On XX XX 20XX, the Property settled.

Dwelling used to produce assessable income

According to the Deceased's records, the Property was used to produce assessable income for the following periods:

•                    XX 19XX to XX 20XX

•                    XX 20XX to XX 20XX

•                    XX XX 20XX to XX XX 20XX.

You have no records to confirm if the Property was used to produce assessable income from XX 20XX to XX XX 20XX. However, you are aware that it was rented out and that there were intervals between leases during this period.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 118-190

Income Tax Assessment Act 1997 section 118-195

Income Tax Assessment Act 1997 section 118-200

Income Tax Assessment Act 1997 subsection 118-200(2)

Income Tax Assessment Act 1997 subsection 118-200(3)

Income Tax Assessment Act 1997 section 118-205

Issue

Capital gains tax - deceased estate - partial main residence exemption

Question 1

Are you entitled to a partial exemption for capital gains tax arising from the sale of the inherited property under section 118-200 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

You are not entitled to a full main residence exemption. However, you are entitled to a partial exemption for capital gains tax arising from the sale of the inherited property under section 118-200 of the Income Tax Assessment Act 1997 (ITAA 1997)

You must adjust the partial exemption for:

•         The Commissioner's exercise of the discretion under subsection 118-200(3) of the ITAA 1997 to allow an extension of time for you to dispose of your ownership interest in the dwelling.

•         Inheriting a previously inherited property under section 118-205 of the ITAA 1997.

•         Use of part of the property to produce income for the relevant periods under section 118-190 of the ITAA 1997.

Question 2

Will the Commissioner exercise the discretion under subsection 118-200(3) of the ITAA 1997 to allow an extension of time for you to dispose of your ownership interest in the dwelling?

Summary

Having considered your circumstances and the relevant factors the Commissioner will allow an extension of time. Further information about the Commissioner's discretion can be found by searching ato.gov.au for 'QC 66057'.

Question 3

Do you need to adjust the partial exemption to increase any non-main residence days due to the Deceased using the Property to produce assessable income under section 118-190 of the ITAA 1997?

Summary

You must adjust the partial exemption to increase any non-main residence days due to the Deceased using the Property to produce assessable income under section 118-190 of the ITAA 1997.

Detailed reasoning

Full main residence exemption

Subsection 118-195 of the ITAA 1997 states that if you own a dwelling in your capacity as a beneficiary in a deceased estate, or you owned it as the trustee of a deceased estate, that you are exempt from tax on any capital gain made on the disposal of the property if:

•         The property was acquired by the deceased before 20 September 1985, or

•         The property was acquired by the deceased on or after 20 September 1985 and the dwelling was the deceased's main residence just before the deceased's death and was not then being used for the purpose of producing assessable income, and

•         Your ownership interest ends within 2 years of the deceased's death.

In your case, you have not met the requirements of section 118-195 of the ITAA 1997 as the Deceased acquired the Property after 20 September 1985, and used part of the Property to produce assessable income just before their death.

Partial exemption

Section 118-200 of the ITAA 1997 considers eligibility for a partial exemption for deceased estate dwellings when you are not able to apply section 118-195 of the ITAA 1997.

You calculate your capital gain or capital loss using the formula set out in subsection 118-200(2) of the ITAA 1997:

CG or CL amount × Non-main residence days ÷ Total days

non-main residence days is the sum of:

(a)  If the deceased acquired the ownership interest on or after 20 September 1985 - the number of days in the deceased's ownership period when the dwelling was not the deceased's main residence; and

(b)  The number of days in the period from the death until your ownership interest ends when the dwelling was not the main residence of an individual referred to in item 2, column 3 of the table in section 118-195.

total days is:

(a)  If the deceased acquired the ownership interest before 20 September 1985 - the number of days in the period from the death until your ownership interest ends; or

(b)  If the deceased acquired the ownership interest on or after that day - the number of days in the period from the acquisition of the dwelling by the deceased until your ownership interest ends.

Commissioner's discretion under subsection 118-200(3) of the ITAA 1997

Where a trustee or beneficiary of a deceased estate cannot access a CGT exemption under section 118-195 of the ITAA 1997, section 118-200 of the ITAA 1997 may provide a partial exemption.

Subsection 118-200(3) of the ITAA 1997 ensures that for post-CGT dwellings, where the trustee or beneficiary's ownership interest ends within two years of the deceased's death (or for a longer period allowed by the Commissioner), the period between the deceased's death and when their ownership interest ends can be ignored when calculating a capital gain or a capital loss.

The Commissioner would be expected to exercise discretion in situations such as where:

•         The ownership of a dwelling or a will is challenged;

•         The complexity of the deceased estate delays the completion of the administration of the estate;

•         A trustee or beneficiary is unable to attend to the deceased estate due to unforeseen or serious personal circumstances arising during the two-year period (for example, the taxpayer or a family member has a severe illness or injury); or

•         Settlement of a contract of sale over the dwelling is unexpectedly delayed or falls through for circumstances outside the beneficiary or trustee's control.

In exercising the discretion, the Commissioner is expected to consider whether and to what extent the dwelling was used to produce assessable income and the period that the trustee or beneficiary held the ownership interest in the dwelling.

In your case, the Commissioner will allow a longer period for you to dispose of the property considering the circumstances and complexity of administering the estate, as required by the Will. You will not be required to include the 'non-main residence days' or the 'total days' in the partial exemption calculation for the period after the Deceased's death.

Inheriting a previously inherited property

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 you and the previous beneficiaries.

Subsection 118-205(1) of the ITAA 1997 provides that you must adjust the formula in subsection 118-200(2) if the ownership interest of the deceased individual referred to in section 118-200 (the most recently deceased) passed to the individual on or after 20 September 1985 as a beneficiary in, or the individual owned it as a trustee of, a deceased estate.

Subsection 118-205(2) of the ITAA 1997 states that you add to the component total days in the formula the fewer of:

(a)  The number of days between 20 September 1985 and the day when the interest passed to or was acquired as trustee by the most recently deceased; or

(b)  The number of days between the time when an ownership interest in the dwelling was last acquired on or after 20 September 1985 by an individual except as a beneficiary in a deceased estate or as trustee of a deceased estate and the day when the interest passed to or was acquired as trustee by the most recently deceased.

Subsection 118-205(3) states that for the component non-main residence days in the formula, you add the days that the dwelling was not the main residence of one or more of:

(a)  An individual who owned the dwelling at the time of the individual's death; or

(b)  An individual who, immediately before the death of an individual referred to in paragraph (a), was the spouse of that individual (except a spouse who was living permanently separately and apart from the individual); or

(c)   An individual who had a right to occupy the dwelling under a will; or

(d)  An individual to whom an ownership interest in the dwelling passed as a beneficiary in, or who acquired ownership interest in the dwelling as trustee of a deceased estate.

In your case, your Grandparents were the original owners, and they used the property as their main residence. You must add to the total days the period from 20 September 1985 until the Deceased acquired the property from your Grandparents in 19XX.

You do not add any days to the non-main residence days in this calculation. The Property was the Deceased's main residence until their death, and you can ignore the period after their death by virtue of subsection 118-200(3) as explained above.

Use of the dwelling to produce assessable income

Usually, you cannot get the full main residence exemption if you acquired your dwelling on or after

20 September 1985, used it as your main residence and you:

•         Used any part of it to produce income during all or part of the period you owned it, and

•         Would be allowed a deduction for interest had you incurred on money borrowed to acquire the dwelling (interest deductibility test).

Section 118-190 of the ITAA 1997 is directed at reducing the main residence exemption and only allowing you a partial exemption if the property is used for income producing purposes. In your case, a partial main residence exemption applies for the period in which the Deceased used part of the property to produce assessable income during their ownership period.

Paragraph 4 of Taxation Determination TD 1999/66 Income tax: capital gains: what factors should be taken into account in determining the 'amount that is reasonable' in applying subsection 118-190(2) of the Income Tax Assessment Act 1997? provides the general rule for apportioning the main residence exemption is to adjust based on floor area and the period of income-producing use.

Subsection 118-190(1) provides an example that you can be apply to your circumstances. It explains that where you acquire a house as a beneficiary in a deceased estate, rent it out for 12 months and sell within 2 years of the deceased's death, that you can ignore the rental period as the exemption does not require the house to be your main residence during the 2 years after death.

In your case, section 118-190 of the ITAA 1997 requires you to increase the non-main residence days based on X% of the floor space, and for the relevant periods when the Property was used to produce income from 19XX until the deceased's death.

Loss of records regarding rental income

Section 121-20 of the ITAA 1997 outlines that you must keep records of every act, transaction, event or circumstance that can reasonably be expected to be relevant to working out a capital gain or loss.

Subsection 121-20(5) of the ITAA 1997 specifies that if the necessary records of an act, transaction, event or circumstance do not already exist, you must reconstruct them or have someone else reconstruct them.

Application to your circumstances

You are not eligible for a full main residence exemption on the disposal of the Property, as X% of the post-CGT dwelling was used by the Deceased to produce assessable income during their ownership period. However, you are eligible for a partial main residence exemption.

The Commissioner will exercise the discretion to allow further time for you to dispose of the property. We consider the extenuating circumstances presented and the complexity of administering the estate as required by the Will are sufficient to grant the extension.

You must use the formula under subsection 118-200(2) of the ITAA 1997 to calculate any capital gain.

The effect of the various adjustments on the formula include:

•         A favourable adjustment allowing the 2-year Commissioner's discretion to dispose of the dwelling in accordance with subsection 118-200(3) of the ITAA 1997 (i.e., ignoring the period after death).

•         A favourable adjustment due to the increase in total days pursuant to section 118-205 of the ITAA 1997, factoring in the Deceased had inherited the Property.

•         An unfavourable adjustment given part of the Property was used to produce income during the Deceased's ownership period, pursuant to section 118-190 of the ITAA 1997. The non-main residence days of the calculation is adjusted based on the X% floor area use of the Property.

The adjusted formula is set out below:

•         Non-main residence days equates to the number of days during the period from 19XX until the deceased's death on XX XX 20XX, when the Property was used to produce income, adjusted based on X% of the floor space.

•         Total days equates to the number of days from 20 September 1985 until the Deceased's death on XX XX 20XX.

Note: You ignore the period (non-main residence days and total days) after the Deceased's death.

According to the deceased's records, the property was used to produce assessable income by the deceased for the following periods:

•         XX 19XX to XX 20XX.

•         XX 20XX to XX 20XX.

•         XX XX 20XX to XX XX 20XX.

The period from XX XX 20XX to XX XX 20XX

Due to a system crash the rental agency has no records prior to 20XX, however the agent confirmed there were rooms rented from XX XX 20XX to XX XX 20XX. Therefore, you do not know if from XX 20XX to XX XX 20XX if there was a period where the property was not producing assessable income. However, you can confirm that there were intervals between leases at times during this period.

When calculating any capital gain or capital loss on the disposal of the Property, and in the absence of any rental records, you have stated you will treat the period from XX XX 20XX to XX XX 20XX as an income producing period. If you can reconstruct or have someone reconstruct accurate records for this period; you can factor this into your CGT calculations pursuant to subsection 121-20(5) of the ITAA 1997.

You are entitled to apply the 50% discount when calculating the capital gain as you have held your ownership interest for more than 12 months.

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