Edited version of private advice

Authorisation Number: 1052078462770

Date of advice: 31 January 2023

Ruling

Subject: CGT - deceased estate sale of replacement dwelling, not purchased under the terms of the will

Question 1

Can the trustees of the Estate of the deceased disregard any capital gain arising from the sale of the replacement property in accordance with section 118-210(3) of the Income Tax Assessment Act 1997 (ITAA 1997).

Answer

No.

Section 118-210 of the ITAA 1997 does not apply to the sale of the replacement property as it was not acquired under the authority of the deceased's will.

Question 2

If the answer to question 1 is 'No", can the trustees of the Estate of the deceased partially disregard any capital gain arising from the sale of the replacement property in accordance with section 118-210(4) of the ITAA 1997?

Answer

No.

Section 118-210 does not apply to the trustees.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

31 October 20XX

Relevant facts and circumstances

The deceased passed away on xx July 19xx.

The deceased was an Australian resident for tax purposes at the time of her passing.

Prior to their passing, the deceased resided with two of her daughters, Beneficiary A and Beneficiary B at the original property.

On xx March 19xx, Beneficiary A married and moved out of the original property.

Clause 2(b) of the deceased's will provides:

As to my residence (address deleted) aforesaid UPON TRUST to allow each of my daughters Beneficiary B and the said Beneficiary A to have the use and occupation thereof free of rent so long as she shall remain unmarried and think fit to reside therein such of them as do reside paying all rates taxes and insurance and keeping the property maintained and repaired to the satisfaction of my trustees PROVIDED HOWEVER that in the event of both of my daughters the said Beneficiary B and Beneficiary A marrying or ceasing to occupy the premises as their residence THEN I DIRECT my trustees to sell and dispose of the said residence and to divide the proceeds of such sale equally between such of my daughters the said Beneficiary A Beneficiary C and Beneficiary B and my daughters Beneficiary D and Beneficiary E as shall survive me if more than one in equal shares.

Following the passing of the deceased, Beneficiary B continued to reside at the original property in accordance with clause 2(b) of the deceased's Will.

In 19xx, Beneficiary B suffered a permanent back injury in a car crash.

In 19xx, the beneficiaries and executors met and agreed that Beneficiary B was incapable of managing the original property due to her back injury and the age of the premises, and that the family did not have the fiscal resources to update and maintain the original property. The executors of the estate formed the view that the intent of the deceased's will was to provide a home for any unmarried children for as long as they live.

On xx January 19xx, the executors of the deceased's estate entered into a contract to sell the original property.

On xx February 19xx, Beneficiary A and Beneficiary C as trustees of the deceased's estate, Beneficiary A and Beneficiary B as the life tenants and Beneficiary A, Beneficiary C, Beneficiary B, Beneficiary D and Beneficiary E as the remaindermen entered into a deed (the original family deed). Pursuant to the original family deed:

      i.        The life tenants and remaindermen directed the trustees of the deceased's estate to sell the original property and to purchase the replacement property using the sale proceeds; and

     ii.        The life tenants and remaindermen declared and acknowledged that on completion of the purchase of the replacement property that the replacement property would be held by the trustees of the deceased's estate upon the same trusts as declared in the will concerning the original property.

The original family deed was stamped by the Office of State Revenue on xx March 19xx.

Beneficiary B occupied the original property as her residence until completion of the sale of that property. Following completion of the sale of the original property and the completion of the purchase of the replacement property, Beneficiary B occupied the replacement property as her main residence.

Beneficiary B continued to occupy the replacement property as her main residence until her passing on xx November 20xx.

During her occupancy of the replacement property, Beneficiary B remained unmarried and continued to pay all rates, taxes and insurance and kept the property maintained and repaired.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 118-210

Reasons for decision

Question 1

Subdivision 118-B of the ITAA 1997 contains the rules for situations when capital gains and losses are ignored for main residence dwellings. There are special rules for dwellings that pass from, or are owned by, a trustee of a deceased estate.

Where a dwelling is acquired by a trustee in accordance with the will of the deceased for occupation by an individual, provided that the dwelling was the individual's main residence for the entire period, any capital gain or loss resulting from the disposal of the dwelling is disregarded in accordance with section 118-210 of the ITAA 1997.

The prerequisite for section 118-210 of the ITAA 1997 applying is stated under subsection 118-210(1) of the ITAA 1997: "This section applies if you are the trustee of a deceased estate and, under the deceased's will, you acquire an ownership interest in a dwelling for occupation by an individual [emphasis added]".

The issue of when a trustee of a deceased estate acquires an ownership interest under the will of a deceased person is considered in Taxation Determination TD 1999/74: Income tax: capital gains: in what circumstances does a trustee of a deceased estate acquire an ownership interest in a dwelling 'under the deceased's will' for the purposes of subsection 118-210(1) of the Income Tax Assessment Act 1997. In order for a dwelling to be acquired under a will, there needs to be a connection between the trustee's acquisition of an ownership interest in a dwelling and the deceased's will. The connection required is not a strict one.

TD 1999/74 also states that a trustee acquires an ownership interest in a dwelling under the will of a deceased person for the purposes of subsection 118-210(1) if the interest is acquired in accordance with the terms of the will, or in accordance with the terms of the will as modified by any court order. The trustee also acquires an interest under the deceased's will if they acquire it in pursuance of the will or under the authority of the will.

A trustee may also have general rights created under State trustee legislation, such as the Trustee Act 1925 (NSW), to purchase a dwelling for the occupation by an individual beneficiary. For example, section 14DA of the Trustee Act 1925 gives the trustee the power to acquire dwelling houses for beneficiaries. These rights and powers are created under the relevant state or territory trustees' legislation and not under the deceased's will.

This issue is considered in the West Australian Court of Appeal case of Caratti v Commissioner of State Revenue [2017] WASCA 128 (Caratti). In Caratti, the appellant was the trustee of a testamentary trust established by his wife who had passed away in May 2012. The will gave the appellant various powers, including the power to sell or to postpone the sale of the family home. The will contained no grant of a right by which a beneficiary could use the property as a residence.

The home had been owed by the appellant's wife since 1988 and had been exempt from land tax as her primary residence up until her death. The appellant and one of the deceased's sons (M) continued to live in the property as their primary residence after the death. The property had been treated as exempt by the Commissioner in the 2013/14 land tax year.

In February 2015, the Commissioner reassessed the land for land tax for the 2013/14 land tax year and issued an original assessment for tax for the 2014/15 year. Following a disallowed objection, the appellant sought review of the objection decision from the Tribunal on the grounds that the land was exempt from land tax under, relevantly, section 22 of the Land Tax Assessment Act 2002 (the Act). Section 22(b)(ii) provides for exemption where a person identified in a will exercises a right granted under the will to use a property as a primary residence.

The appellant argued that M had a right to use the property as a primary residence by virtue of an earlier arrangement ("the arrangement") between the appellant and his wife under which it was intended that M would reside in the property for as long as he wished. The Tribunal found that neither the appellant nor M had a "right under" the will to use the property as a place of residence and, accordingly, the basis for exemption had not been made out. The appellant appealed to the Court of Appeal.

Before the court the appellant contended that, as trustee, he had given effect to the arrangement by exercising power under the will to postpone the sale of the property and power under s 24 of the Trustees Act 1962 to retain the property as a residence for a beneficiary. This amounted to a right granted to M under the will to use the property as his residence for as long as he wished, in accordance with s 22(b)(ii)(I) of the Act.

The Court of Appeal dismissed the appeal and held that section 22(b)(ii) of the Act required that an individual identified in the will have a right under the terms of the will to use the property as a place of residence. In this case the will gave no such right to M. Neither pre-testamentary arrangements of the kind referred to by the appellant, nor post-testamentary decisions by the trustee to allow M to reside at the property were relevant to the application of s 22(b)(ii).

At paragraph [25]-[26] of its judgment, the Court of Appeal stated:

[25] ... Accordingly, attention is directed to the terms of the Will. The Will gives no right of residence to Mr Michael Caratti. He plainly has no such right under the terms of that instrument. Pre-testamentary arrangements of the kind referred to by the appellant are irrelevant to the application of s 22(b)(ii) of the Land Tax Act on its proper construction.

[26] Equally irrelevant is any post-testamentary decision by the appellant as trustee appointed under the Will to allow Mr Michael Caratti to reside at the Property. Insofar as it is alleged that Mr Michael Caratti has a right to reside at the Property pursuant to some agreement entered into with the appellant as trustee in the exercise of the appellant's powers under s 24 of the Trustees Act, the right (if it be a right) derives from the post-testamentary agreement, or, perhaps, from the appellant's exercise of a power under s 24 of the Trustees Act. It is not a right given by the terms of the Will, ie, a 'right under the will' given to 'an individual identified in the will' within the meaning of s 22(b)(ii) of the Land Tax Act. [emphasis added]

As discussed in ATO Interpretative Decision ATO ID 2003/109 Capital gains tax: Deceased estate - main residence exemption, the general rule of construction is that the intent of the deceased must be ascertained from the words of the will and that one cannot speculate or guess after that intention.

In your case, clause 2 of the deceased's will created a right of use and occupancy in the original property for two of the deceased's daughters for so long as they remained unmarried and chose to occupy the original property as their residence. Clause 2 of the deceased's will further provided that should both daughters with the right of use and occupancy either marry, or cease to reside in the original property, then the original property was to be sold and the proceeds distributed equally amongst named beneficiaries.

The purchase of the replacement property by the trustees was not done pursuant to the will of the deceased, but rather by agreement of the executors and the beneficiaries after the will was made. The beneficiary who had a right of use and occupancy in the original property had no right under the will to demand that the executors purchase a replacement property when the original property became unsuitable.

Consequently, it is considered that section 118-210 of the ITAA 1997 does not apply to the sale of the replacement dwelling as it wasn't acquired under the deceased's will for occupation by a named individual, as required by subsection 118-210(1) of the ITAA 1997.

You are unable to disregard any capital gain made on the disposal of the replacement dwelling.

Question 2

For the same reasons outlined in the response to question 1, the Commissioner does not consider that the trustees have acquired the replacement dwelling under the will and therefore section 118-210 does not apply.