Edited version of private ruling

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Ruling

Subject: capital gains tax and deceased estates

Questions and answers:

1. Is any capital gain or loss from the sale of the properties included in the assessable income of the deceased estate?

Yes.

2. Does the deceased estate pay tax on any capital gain made from the sale of the properties?

No.

This ruling applies for the following period:

1 July 2010 to 30 June 2011.

The scheme commenced on:

1 July 2010.

Relevant facts:

You were appointed executor of a deceased estate.

You were also a beneficiary of the estate.

The deceased passed away in 2009.

The distributions to all beneficiaries, including the distribution of the residue of the estate, were made in the 2011 income tax year.

None of the beneficiaries were minors when they became presently entitled to their share of the estate.

None of the beneficiaries were under a legal disability when they became presently entitled to their share of the estate.

The assets of the deceased included the following two properties:

· property one, and

· property two.

The deceased became the sole owner of both properties before 20 September 1985.

Property one was the main residence of the deceased.

Property two was a vacant lot.

Neither property was ever used by the deceased for income producing purposes.

In your capacity as executor of the deceased estate, you entered into contracts to sell properties one and two.

The contracts to sell properties one and two both settled more than two years after the date of death of the deceased.

Neither you, nor any other beneficiary of the deceased estate had a right to occupy property one under the will.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 10-5.

Income Tax Assessment Act 1997 Section 102-5.

Income Tax Assessment Act 1997 Section 102-20.

Income Tax Assessment Act 1997 Section 102-30.

Income Tax Assessment Act 1997 Section 104-10.

Income Tax Assessment Act 1997 Section 108-5.

Income Tax Assessment Act 1997 Section 109-55.

Income Tax Assessment Act 1997 Section 110-25.

Income Tax Assessment Act 1997 Section 110-55.

Income Tax Assessment Act 1997 Section 115-5.

Income Tax Assessment Act 1997 Section 115-10.

Income Tax Assessment Act 1997 Section 115-15.

Income Tax Assessment Act 1997 Section 115-20.

Income Tax Assessment Act 1997 Section 115-25.

Income Tax Assessment Act 1997 Section 115-30.

Income Tax Assessment Act 1997 Section 115-100.

Income Tax Assessment Act 1997 Section 115-25.

Income Tax Assessment Act 1997 Section 116-20.

Income Tax Assessment Act 1997 Section 118-110.

Income Tax Assessment Act 1997 Section 118-195.

Income Tax Assessment Act 1997 Section 118-200.

Income Tax Assessment Act 1997 Section 128-15.

Income Tax Assessment Act 1936 Section 6(1).

Income Tax Assessment Act 1936 Division 6.

Income Tax Assessment Act 1936 Section 95.

Income Tax Assessment Act 1936 Section 96.

Income Tax Assessment Act 1936 Section 97.

Income Tax Assessment Act 1936 Section 98.

Income Tax Assessment Act 1936 Subdivision 115-C.

Reasons for decision

Deceased estates, assessable income, trusts and trustees - general

A deceased estate is a trust and remains so until administration of the estate is complete. Generally, administration is complete when the net income of the estate has been established and all of the assets and income of the estate have been distributed to the beneficiaries.

The person nominated under the will to wind up the affairs of the deceased person is the executor and trustee of the deceased estate.

Once probate of the deceased's will has been granted, the executor is free to call up the deceased's assets and liabilities, and to pay the debts and other expenses of the deceased estate.

The net income of the deceased estate is established by the executor after all the income and expenses of the estate have been accounted for.

The assessable income of a deceased estate may include capital gains if any capital gains tax (CGT) assets are disposed of by the executor as part of the administration of the estate.

Real estate, capital gains tax and deceased estates - general

Real estate (including vacant land and land on which there is a dwelling) is a CGT asset.

As a general rule, an assessable capital gain or loss can only be made on a CGT asset acquired on or after 20 September 1985 (post-CGT assets). In most cases, any capital gain or loss made on a CGT asset acquired before 20 September 1985
(pre-CGT assets) is disregarded.

For CGT purposes, if you acquire real estate as the trustee of a deceased estate, you are taken to have acquired the real estate on the day the deceased person died. If the date of death is after 20 September 1985, any real estate you acquire in your capacity as trustee of the deceased estate will be a post-CGT asset in your hands.

Because the deceased passed away in 2009 and ownership of properties one and two is taken to have passed to you the date the deceased passed away, both assets became post-CGT assets in your hands as trustee of the deceased estate.

If you dispose of a CGT asset that you acquire as trustee of a deceased estate, CGT event A1 happens. Generally, the time of the event is when the contract for the disposal is entered into. If there is no contract, the event occurs when the change of ownership takes place.

When a CGT event happens to a CGT asset you own as trustee of a deceased estate, you make a capital gain or loss at the time of the event, depending on whether the capital proceeds from the CGT event are more or less than the cost base/reduced cost base of the CGT asset.

In the case of the disposal of real estate, the capital proceeds is the amount of money you receive or are entitled to receive for the disposal of the asset.

If the capital proceeds from the disposal are greater than the asset's cost base, a capital gain is made. A capital loss results if the capital proceeds are less than the asset's reduced cost base.

In some cases, an exemption may apply that allows the trustee of a deceased estate to reduce, or disregard (and therefore not include in the assessable income of the deceased estate), any gain or loss made as a result of a CGT event. Where applicable, such exemptions are provided for by the tax law.

If no exemption applies, any assessable gain made from a CGT event is included in the assessable income of the deceased estate in the income year in which the CGT event happens.

The Commissioner has no authority to allow the trustee of a deceased estate to reduce or disregard any assessable gain outside of the exemptions provided for by the tax law.

Methodology - determining net capital gains/losses for an income tax year

The net capital gain of an individual or trust in a particular income year is:

· the total capital gains for the year,

minus

· the total capital losses for the year and any unapplied net capital losses from earlier income years

minus

· any applicable CGT discount.

Where the total capital losses for an income year are more than the total capital gains, the difference is a net capital loss for the year.

A net capital loss can be carried forward to later income years to be deducted from future capital gains.

Capital losses or a net capital loss cannot be deducted from income. However, there is no time limit on how long a net capital loss can be carried forward.

In the case of individuals and trusts, the discount that can be applied under the above methodology is 50% but it can only be applied to assets that have been owned for at least 12 months prior to disposal. For the purposes of this 12 month ownership test, the executor of a deceased estate is taken to have acquired an asset on the day the deceased died if that asset was a pre-CGT asset in the hands of the deceased.

As trustee of the deceased estate, and because properties one and two were both pre-CGT assets in the hands of the deceased, you are taken to have acquired both properties on the day the deceased died for the purposes of the 50% CGT discount.

Determining the cost base/reduced cost base of CGT assets acquired by the trustee of a deceased estate

Generally, when a person acquires a CGT asset the cost base/reduced cost base of the asset includes the cost of acquiring it, as well as certain other costs associated with acquiring, holding and disposing of the asset.

There are five elements that make up the cost base of a CGT asset. These are:

· The first element: money or property given for the asset.

· The second element: incidental costs of acquiring the asset or that relate to the CGT event.

· The third element: costs of owning the asset.

· The fourth element: capital costs to increase or preserve the value of your asset or to install or move it.

· The fifth element: capital costs of preserving or defending your ownership of or rights to the asset.

The reduced cost base of a CGT asset has the same five elements as the cost base, except for the third element. The third element of the reduced cost base relates to balancing adjustments which do not apply to residential real estate.

For trustees of deceased estates, the rules for determining the first element of the cost base/reduced cost base of a CGT asset that passes to them as a trustee are modified, depending on the date the deceased person acquired the asset.

For CGT assets acquired by the deceased person before 20 September 1985 (pre-CGT), the first element of your cost base/reduced cost base (that is, the amount you are taken to have paid for the asset) is the market value of the asset on the day the person died.

Properties one and two were both acquired by the deceased before 20 September 1985. Accordingly, both properties were pre-CGT assets in the hands of the deceased and the first element of your cost base/reduced cost base for properties one and two will be the market value of the properties on the day the person died.

Disposal of properties one and two - CGT implications

Property one

When ownership of a deceased's dwelling (including the land on which the dwelling is situated) passes to you as the executor of the deceased's estate, you may be fully or partially exempt from any capital gain made on the subsequent disposal of the dwelling.

Section 118-195 of the Income Tax Assessment Act 1997 (ITAA 1997) sets out the circumstances in which a full exemption is available.

In cases where the deceased passed away on or after 20 September 1985, but acquired the dwelling before that date, section 118-195 of the ITAA 1997 provides that if you have an ownership interest in the dwelling as trustee of the deceased estate and you dispose of that dwelling in your capacity as trustee, you can disregard any capital gain or loss made from the disposal if either of the following applies:

· you disposed of your ownership interest within two years of the person's death - that is, if the dwelling was sold under a contract, settlement occurred within two years (there is no discretion under the tax law for the Commissioner to extend the two year period), or

· from the deceased's death until you disposed of your ownership interest, the dwelling was the main residence of one or more of:

o a person who was the spouse of the deceased immediately before the deceased's death,

o an individual who had a right to occupy the home under the deceased's will, or

o you, as a beneficiary, if you disposed of the dwelling as a beneficiary

If either of the above can be applied to your circumstances, a full exemption is available regardless of whether or not the dwelling was the main residence of the deceased person.

The full exemption does not apply to the disposal of property one because:

· you did not dispose of property one within two years of the death of the deceased,

· the deceased's spouse passed away prior to the deceased's death,

· no individual had a right to occupy property one under the terms of the deceased's will, and

· the disposal of the property was brought about by you in your capacity as trustee of the estate, not by an individual to whom ownership of the dwelling passed as a beneficiary.

When you dispose of a deceased person's home in your capacity as trustee of a deceased estate and a full exemption from CGT for the disposal is not available to you, you may be entitled to a partial exemption under the provisions of section 118-200 of the ITAA 1997.

To determine if you are entitled to a partial exemption, section 118-200 of the ITAA 1997 specifies that you calculate your capital gain loss using the following formula:

· amount of capital gain or loss × non-main residence days

total days

For dwellings acquired by the deceased before 20 September 1985, section 118-200 of the ITAA 1997 specifies that:

· 'Non-main residence days' is the number of days in the period from the date of death of the deceased until settlement of the contract for sale of the dwelling when the dwelling was not the main residence of one of the following:

o the spouse of the deceased,

o an individual who had a right to occupy the dwelling under the will, or

o you, as a beneficiary, if you disposed of the dwelling as a beneficiary.

· 'Total days' is the number of days from the deceased's death until you disposed of your ownership interest.

The 'non-main residence days' and the 'total days' in the above calculation will be the same because since the death of the deceased, property one has never been the main residence of any of the people listed above. Therefore, no exemption for any capital gain made from the disposal of property is available to you.

Property two

There are no exemptions in the tax law that allow a capital gain made from the disposal of vacant land that was never the main residence of an individual to be disregarded.

Property two was vacant land from the time it was acquired by the deceased until the time you disposed of it in your capacity as executor of the deceased's estate. Therefore, no exemption is available that would allow you to reduce or disregard any capital gain made from the disposal of property two.

Application of the tax law to your disposal of properties one and two

Properties one and two were pre-CGT assets in the hands of the deceased but became post-CGT assets in your hands because you are taken to have acquired each property on the day the deceased died in 2009.

CGT event A1 happened when you disposed of properties one and two.

For each property, if the capital proceeds from the disposal are greater than the cost base of the property, you will have made a capital gain on the disposal and that capital gain will be included in the assessable income of the deceased estate.

The first element of your cost base for each property will be the market value of the property on the day the deceased died.

As trustee of the deceased estate, you are entitled to apply the 50% discount when determining the net capital gain/loss of the estate.

Taxation of deceased estates - general

The provisions relating to the taxation of trusts, and therefore deceased estates, are contained in Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936).

A trust created by a deceased estate is not a taxable entity in its own right. Rather, the net income of a deceased estate will be assessed for taxation purposes either in the hands of:

· the beneficiaries of the estate who are presently entitled to the income of the estate and not under a legal disability, or

· the executor (trustee) of the estate.

Section 97 of the ITAA 1936 provides that where any beneficiary not under a legal disability is presently entitled to a share of the net income of the trust estate, that share of the net income of the trust estate shall be included in his or her assessable income.

A person is considered to be under a legal disability if they are under the age of 18 years, are bankrupt, or been declared legally incapable because of a mental condition.

The leading Australian case on present entitlement under a trust arising during the course of administration of an estate is the decision of the High Court of Australia in F.C. of T. v. Whiting (1943) 68 CLR 199; 7 ATD 179. The Court held that a beneficiary of a deceased estate cannot be presently entitled to the income of the estate until the estate has been fully administered.

The net income of the trust estate and whether any beneficiary is presently entitled to a share of that income are determined on the last day of the financial year.

This means that, on the last day of the income year, provided a beneficiary has become presently entitled to a share of the income of the trust estate and they are not under a legal disability, the beneficiary is assessable on their share of the net income of the trust.

A beneficiary who has received a share of the net income of a trust estate is presently entitled to it.

The net income of a deceased estate is calculated in accordance with section 95 of the ITAA 1936. The calculation required includes in the net income of the deceased estate all assessable income derived by the estate for the whole of the income year concerned.

The distributions to all beneficiaries of the estate were made in the 2011 income tax year. As none of the beneficiaries were under a legal disability, all beneficiaries were presently entitled to their share of the net income of the estate on 30 June 2011.

It is the beneficiaries, not the estate, or you in your capacity as trustee of the estate, who will be assessable on the net income of the estate.

The net income of the estate will include any assessable income derived by the estate in the 2010-11 financial year, including any net capital gain arising from the disposal of properties one and two.