Edited version of private advice

Authorisation Number: 1052051265795

Date of advice: 20 December 2022

Ruling

Subject: Capital gains tax

Question

Will capital gains tax be payable on the sale of your 50% ownership interest in the inherited property?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX.

The scheme commences on:

01 July 20XX.

Relevant facts and circumstances

The property was purchased before 20 September 1985 by Person J, Person I and Person B as joint tenants

Person J passed away before 20 September 1985.

Ownership of the property changed to Person I and Person B as joint tenants.

Person I passed away before 20 September 1985.

100% of the ownership of the property went to Person B.

Before 20 September 1985 Person K and Person P purchased a half share of the property as tenants in common with Person B.

Sometime after 20 September 1985 Person K passed away.

Ownership of the property changed to Person P and Person B as tenants in common.

Approximately 10 years later Person P passed away.

Ownership of the property changed to Person D (you) and Person B as tenants in common.

The Last Will and Testament of Person P advised the following:

• You were appointed executor of Person P's deceased estate; and
• Person B was given the unrestricted right of the use of the property for as long as they wish and upon Person B's death or when they ceased to live permanently in the property then the interest is directed to form part of rest and residue of the estate which is left to Person D.

A short time later Person B moved into aged care.

A few years later Person B passed away.

The Last Will and Testament of Person B advised the following:

I direct that the rest of my estate be used first to pay my estate liabilities. After payment of my estate liabilities, I give the rest of my property to Person D if they survive me.

The property has been the principal place of residence for Person B since before 20 September 1985 and was never used for investment purposes or to generate income.

The property is less than 2 hectares.

A short time later the property sold for a sale price that was higher than its cost base, and settlement occurred on the property.

The estate of Person B is still being administrated by the Public Trustee.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section110-25

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 section118-190

Income Tax Assessment Act 1997 section 118-195

Income Tax Assessment Act 1997 section128-15

Reasons for decision

Question

Will capital gains tax be payable on the sale of your 50% ownership interest in the inherited property?

Detailed reasoning

Capital gains tax provisions

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a capital gain or capital loss is made only if a CGT even happens to a CGT asset. The property is a CGT asset (section 108-5 of the ITAA 1997).

CGT event A1 happens if you dispose of a CGT asset as per subsection 104-10(1) of the ITAA 1997.

Subsection 104-10(2) of the ITAA 1997 provides that you dispose of a CGT asset if a change in ownership occurs from you to another entity, whether because of some act or event or by operation of law.

You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-10(4) of the ITAA 1997).

Main residence exemption

Generally, you disregard a capital gain or capital loss from a CGT event that happens to your ownership interest in a dwelling that is your main residence under section 118-110 of the ITAA 1997.

To get the full exemption from CGT:

•         the dwelling must have been your main residence for the whole period you owned it

•         you must not have used the dwelling to produce assessable income, and

•         any land on which the dwelling is situated must be two hectares or less.

Deceased estate

Section 118-195 of the Income Tax Assessment Act 1997 (ITAA 1997) provides a capital gains tax (CGT) exemption to beneficiaries and trustees where a CGT event happened to a dwelling they acquired from a deceased estate.

Subsection 118-195(1) of the ITAA 1997 provides that a capital gain or loss in this circumstance will be disregarded if:

1)    the deceased acquired their ownership interest in the dwelling on or after 20 September 1985,

2)    the dwelling was the deceased's main residence just before they died,

3)    the dwelling was not then being used for the purpose of producing assessable income, and

4)    your ownership interest in the dwelling ends within two years of the deceased's death, or within a longer period allowed by the Commissioner.

Right to reside

Alternately, subsection 118-195(1) of the ITAA 1997 also provides that a CGT exemption may be available to beneficiaries and trustees where a CGT event happened to a dwelling they acquired from a deceased estate and the dwelling was, from the deceased's death until your ownership interest ends, the main residence of an individual who had a right to occupy the dwelling under the deceased's will.

Practical Compliance Guideline PCG 2019/5 The Commissioner's discretion to extend the two-year period to dispose of dwellings acquired from a deceased estate outlines the factors that the Commissioner will consider when determining whether or not to exercise their discretion to extend the two-year period under section 118-195 of the ITAA 1997. Generally, the Commissioner will allow a longer period where the sale of the dwelling could not be settled within two years of the deceased's death due to reasons beyond your control.

The factors that the Commissioner will consider to be favourable are listed in paragraph 12 of the PCG as follows:

•         the ownership of the dwelling, or the will, is challenged

•         a life or other equitable interest given in the will delays the disposal of the dwelling

•         the complexity of the deceased estate delays the completion of administration of the estate, or

•         settlement of the contract of sale of the dwelling is delayed or falls through for reasons outside of your control.

Partial Main Residence Exemption

Under subsection 118-190(1) of the ITAA 1997, your main residence exemption is reduced, and you only get a partial exemption if:

a)    the dwelling which was your main residence was used for the purpose of producing assessable income; and

b)    you had interest on money borrowed to acquire the dwelling, you could have deducted some or all of that interest.

Subsection 118-190(2) of the ITAA 1997 provides that your capital gain is increased reasonably, having regard to the extent to which you would have been able to deduct that interest.

Subsection 118-190(3) of the ITAA 1997 provides that you ignore any use of the dwelling that was to produce assessable income during an absence under section 118-145 of the ITAA 1997, to the extent that it was not used to produce assessable income just before the absence occurred.

Partial main residence is calculated as follows:

A × (B ÷ C)

Where:

•         A is the total capital gain made from the CGT event

•         B is the number of days in your ownership period when the dwelling was not your main residence

•         C is the total number of days in your ownership period.

Cost base and reduced cost base of asset acquired from deceased estate

When a taxpayer's legal personal representative or a beneficiary of the taxpayer's estate acquires an asset as a result of the taxpayer's death, the cost base and reduced cost base of the asset in the hands of the legal personal representative or beneficiary are modified under subsection 128-15(4) of the ITAA 1997.

Asset acquired by deceased before 20 September 1985

If the deceased acquired the asset before 20 September 1985, it was a pre-CGT asset while they owned it. The first element of your cost base - the acquisition cost - is the market value of the asset on the day the deceased died.

If the deceased made a major improvement to the asset on or after 20 September 1985, the improvement is not treated as a separate asset. You are taken to have acquired a single asset.

The cost base of this single asset is the total of:

•         the cost base of the major improvement on the day the person died

•         the market value of the pre-CGT asset, excluding the improvement, on the day the deceased died.

Asset acquired by deceased from 20 September 1985.

If the deceased acquired the asset on or after 20 September 1985, the first element of your cost base - the acquisition cost - is generally the deceased's cost base for the asset on the day they died.

However, the first element of your cost base is the market value of the asset on the day the deceased died if the asset:

•         is a property that passed to you after 20 August 1996 (but not as a joint tenant), and just before the deceased died it was their main residence and was not being used to produce income

•         passed to you as the trustee of a special disability trust.

Discount capital gains

Division 115 of the ITAA 1997 provides the conditions for a discount capital gain.

You make a discount capital gain if the following requirements are satisfied:

•         you are an individual

•         a CGT event happens to a CGT asset of yours after 11:45am (by legal time in the Australian Capital Territory) on 21 September 1999

•         you acquired the CGT asset at least 12 months before the CGT event, and

•         you do not choose to use the indexation method.

For Australian resident individuals the discount percentage is 50%. However, you can only reduce your capital gain after applying all your capital losses for the year and any unapplied net capital losses from earlier years.

In your case, you meet all of the above conditions and therefore are entitled to reduce a capital gain if made, by 50% using the discount method under Division 115.

Application to your situation

You inherited a 50% ownership interest (your 50% interest) in a property from the deceased estate of Person P.

The scope of this private ruling deals with the sale of your 50% interest in the property.

Your 50% interest in the property consists of two shares:

•         Person P's initial ownership interest share

Person P's initial ownership interest share in the property is a pre-CGT asset.

The cost base of Person P's initial ownership interest share in the property is outlined in subsection 128-15(4) of the ITAA 1997 as follows:

Where the asset is a pre-CGT asset in the hands of the deceased taxpayer, the first element of the cost base (and reduced cost base) to the taxpayer's legal personal representative or beneficiary at the time of acquisition by them is the market value of the asset on the day of the taxpayer's death.

Therefore, you have one ownership interest share in the property with a cost base based on the market value of the property on XX XXXX XXX.

•         Person P's other ownership interest share

Person P's other ownership interest in the property was transferred to Person P post-CGT.

As Person P's other ownership interest in the property was a pre-CGT asset for Person K, the cost base of the asset for Person P is based on the market value of the property at Person K's date of death being post-CGT.

As Person P acquired the asset on or after 20 September 1985, the first element of your cost base is Person P's cost base for the asset on the day they died.

Therefore, you have one other ownership interest in the property with a cost base based on the market value of the property on XX XXX XXXX.

Main residence exemption

As neither Person P nor Person K resided in the property as their main residence for any of the ownership period the main residence exemption cannot apply to the property before it was transferred to the beneficiary.

However, as Person P left a right to reside in the property to Person B the main residence exemption applies from when the Person P passed away and ends when Person B moves out of the property.

Therefore, you can apply a partial main residence exemption to both of Person P's ownership interests in the property.

The remainder of your ownership period for each ownership interest are non-main residence days up until the sale of the property.

You are able to apply the 50% discount to the capital gain made as you have owned your 50% share of the property for over 12 months.

Conclusion

You inherited a 50% ownership interest in a property which wasn't the main residence of the deceased. The property was sold, and a capital gain was made. As a capital gain was made on the sale of the property you are liable for capital gains tax.