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1 CGT & deceased estates By Stephanie Flegg, Lawyer & Luis Batalha, Director 3 November 2014 batallion legal keepin it simple Individuals planning to make a will, or who are executors of a deceased estate, should be aware of the possible capital gains tax (CGT) implications of their decisions. Will makers should understand that their estate may be liable for CGT depending on who their assets are left to and how they are dealt with under their will. Executors should appreciate the options available to them, which may lower their CGT, when administering an estate. Executor s liability to CGT In general, an executor can ignore a capital gain or loss which arises from the transfer of an asset to a beneficiary which the deceased owned immediately before dying (ITAA 1997 s ). However, the executor of the estate may make a capital gain or loss if an asset of the deceased passes to a beneficiary who is: a tax exempt entity; the trustee of a complying superannuation fund; or a foreign resident (ITAA 1997 s ). Tax exempt entities If a deceased s post-cgt asset is left to an entity whose income is tax exempt, any capital gain or loss made will be assessed in the estate s final tax return and the estate s assets will fall by the amount needed to pay the tax on any gain (ITAA 1997 ss and 995-1). However, if the exempt entity is a DGR the capital gain or loss can be deducted, in full or in part, on the estate s final tax return (ITAA 1997 ss and (1)). DGRs include certain classes of charitable organisations and public institutions (ITAA 1997 s to ). Only certain types of gifts, which meet special conditions, qualify for a deduction (ITAA 1997 s 30-15). If an individual is considering leaving a gift to an organisation in their will, they should check the Australian Business Register to ensure that the organisation is a DGR and the gift 2014 batallion legal 1

2 is, therefore, potentially deductible to the estate. Also, an individual may wish to leave a gift of specific property, rather than money, in their will to a charity as a gift of money may require the executor of the estate to sell assets and pay CGT. Foreign beneficiaries A capital gain or loss may arise for an estate if a deceased s post-cgt asset is left by an Australian resident to: a non-resident of Australia; and the asset is not real property located in Australia, an asset used in an Australian business or a right or option to acquire either of the above (ITAA 1997 ss and 995-1). Disposal of assets If the executor, or a beneficiary, of an estate sells an asset they may have to pay CGT on the disposal (ITAA 1997 s ). However, there will be no liability for CGT on: disposing an asset acquired for less than $10,000 and used, or kept, primarily for the personal use or enjoyment of the deceased, or their associates. This excludes assets which are collectables such as artworks, jewellery, coins and antiques (ITAA 1997 ss (2), (2), (2) and (3)); disposing of a collectable where the price, or market value, when the asset was acquired was $500 or less (ITAA 1997 ss (2), (2) and (1)); disposing of most motor vehicles (ITAA 1997 s 118-5); dealings with most life insurance policies and superannuation benefits (ITAA 1997 ss and ); transfers of money which is in Australian currency, in cash or deposited in a bank account (ITAA 1997 s ); and disposing of the deceased s main residence, if certain conditions are met (ITAA 1997 s (1) and Taxation Determination TD 1999/70). Main residence No CGT applies to the sale of a main residence by an executor or a beneficiary of a deceased estate if the following conditions are met (ITAA 1997 s (1) and TD 1999/70): 2014 batallion legal 2

3 Asset 1 Post-CGT main residence Requirements Property was: the deceased s main residence at the time of death; not used by the deceased to earn income; and disposed of by the beneficiary within 2 years of the deceased s death or such longer period as the Commissioner allows; or from the date of the deceased s death until it was disposed of, the property was used as the main residence of the deceased s spouse or an individual granted a right of residence under the will of the deceased. 2 Pre-CGT main residence Property was either: disposed of by the beneficiary within 2 years of the deceased s death or such longer period as the Commissioner allows; or from the date of the deceased s death until it was disposed of, the property was used as the main residence of the deceased s spouse or an individual granted a right of residence under the will of the deceased. If the property was not used as the main residence of the deceased for the total period of ownership, the individual may be able to ignore only part of the capital gain when selling the property (ITAA 1997 s ). Cost base of assets The executor and beneficiaries under a will, or a testamentary trust created under a will, are taken to have acquired an asset on the day the deceased died (ITAA 1997 s (2)). When the executor or a beneficiary disposes of an asset acquired from the estate of an Australian resident, the cost base of the asset will be as follows (ITAA 1997 ss , and ): 2014 batallion legal 3

4 Asset acquired 1 Post-CGT asset (not main residence or trading stock) Cost base Deceased s cost base of asset on date of death 2 Pre-CGT asset (not main residence or trading stock) Market value of asset on date of death 3 Deceased s main residence (not used to earn income) Market value on date of death Also, any beneficiary is able to add the expenditure the executor incurred on the asset to its cost base (ITAA 1997 s (5)). Discount on capital gain The executor or a beneficiary of a deceased estate may discount a capital gain by 50% if they dispose of the asset 12 months after: the deceased acquired it, for a deceased s post-cgt assets; or the date of the deceased s death, for a deceased s pre-cgt assets (ITAA 1997 ss to ). Reducing CGT for estate The executor may have to sell assets of the estate in order to meet the liabilities of the estate. If this is the case the executor should consider either: selling the assets of the estate, listed above, that would not attract CGT; or selling the deceased s pre-cgt assets, as they would be acquired by the executor for market value on the date the deceased died and, therefore, likely to result in lower capital gains than assets acquired by the deceased after that date (ITAA (4) Item 4). A will maker can reduce the need for their executor to sell assets by: not creating trusts for the sale of assets in their will; and setting aside enough cash funds to meet the liabilities of their estate batallion legal 4

5 Also, the executor should consider distributing assets, consistent with their power of appropriation, in the form the deceased left them, rather than as cash after the assets are sold (Trustee Act 1925 (NSW) s 46). Capital losses of deceased When a person dies they lose the benefit of any capital losses they have accumulated during their lifetime (Taxation Determination TD 95/47, paragraph 1). Unclaimed net losses cannot be used: to offset against other income of the deceased in the final income tax return; by the trust estate to offset against future capital gains; or by beneficiaries to offset against their own capital gains (TD 95/47, paragraph 2). Elderly or terminally ill taxpayers may, therefore, wish to take advantage of significant unused capital losses by either: selling some assets; or gifting particular assets to their intended beneficiaries before death (ITAA 1997 ss , and (1)). In deciding whether to dispose of assets before death, the taxpayer should, however, take into account social security requirements and the possible stamp duty implications for recipients of gifts (Social Security Act 1991 (Cth) ss 9(1), 1064-G3, 1076 to 1082 and 1123 to 1127A, Duties Act 1997 (NSW) ss 8(1)(a), 11, 13, 21(1)(b) and 63(a)). Testamentary trusts A will may establish a trust which grants life and remainder interests, in certain assets or the income of the estate, to certain beneficiaries. These types of trusts are typically created under a will in cases where the individual wants to provide for a spouse, upon the individual s death, while still ensuring that other beneficiaries, usually children, are left with a significant portion of their assets. A life interest in an asset entitles the owner of the interest to the income from that asset, and in the case of real property usually a right to possession of the property, for their lifetime (Taxation Ruling TR 2006/14, paragraph 6). A remainder interest grants the owner 2014 batallion legal 5

6 of the interest possession of the assets of the trust upon the death of the life interest holder (TR 2006/14, paragraph 6). If a will creates a trust over the assets of a deceased estate any capital gain or loss made on the creation of the trust is ignored (ITAA 1997 s , TR 2006/14, paragraph 15). Also, a distribution of an asset by a trustee of trust created under a will to the ultimate beneficiary is generally ignored (ITAA 1997 ss and , Practice Statement Law Administration PS LA 2003/12, paragraph 3). When the owner of a life interest dies any capital gain or loss that would result from the disposal of their interest in the trust is ignored (ITAA 1997 ss (1)(c) and , TR 2006/14, paragraph 44). If the life or remainder interest owner shows an intentional and unequivocal rejection of their interest in the trust there will be no CGT consequences for that owner by disclaiming their interest (TR 2006/14, paragraphs 29 to 30). Conclusion Individuals should, in drafting their will, consider the possible CGT consequences of making certain gifts. Will makers and executors should consider a strategy for distributing assets to beneficiaries of the estate that causes no, or little, additional CGT to their estate. Ultimately, the individual should weigh up the potential CGT benefits of any disposition against the possible negative non-cgt related consequences batallion legal 6