The Importance Of Timing In Estate And Tax Planning
Tax considerations are important as part of the estate planning process when you are writing or updating your will and considering the assets that make up that estate. Timing plays an important role throughout the Australian tax system and getting the timing right can affect you, or those who inherit from you in terms of the amount of tax due.
Following are two examples which highlight the importance of effective tax planning and timing in selling an inherited property and the two alternative tax outcomes that follow.
Please note: The numbers used are for illustrative purposes only.
Inheriting and/or selling an investment property
Mr and Mrs Young jointly acquired an Australian investment property before the introduction of capital gains tax (CGT) on 20 September 1985 (i.e. pre-CGT asset). Mr Young passed away on 20 September 2018 when the property’s market value was $750,000. As a result, Mrs Young’s ownership of this property is now split as follows:
- 50% retains pre-CGT status; and
50% is taken to be acquired by Mrs Young on 20 September 2018 at $375,000.
Mrs Young’s current Will leaves this investment property to her daughter Emma, a non-resident.
Scenario 1 – If the investment property is sold for $900,000 during Mrs Young’s lifetime
The resulting capital gain will essentially be calculated per this example as follows:
| $ | Notes | |
|---|---|---|
| Sale proceeds ($900,000 x 50%) | 450,000 | Only the post-CGT share of the asset is exposed to CGT. |
| Less: Cost base ($750,000 x 50%) | (375,000) | The cost base is taken to be the market value of the property at the date of Mr Young’s death as noted above. |
| Equals: Gross capital gain | 75,000 | |
| Less: Capital losses | - | Assume nil in this example |
| Equals: Net capital gain | 75,000 | |
| Less: General 50% discount | (37,500) | |
| Equals: Assessable net capital gain | 37,500 | Assessable in Mrs Young’s tax return in the income year according to the contract sale date. Subject to tax at Mrs Young’s marginal tax rates. |
Scenario 2 – If the investment property is sold for $800,000 after Mrs Young’s passing
Alternatively, if Emma inherits the investment property and subsequently sells it, then the sale will be subject CGT in Emma’s hands (unless it is sold by the legal personal representative during the Estate’s administration which is an alternative scenario that may also be separately considered by contacting our office).
In respect to the 50% interest in the property originally acquired by Mrs Young prior to 20 September 1985 (i.e. pre-CGT), Emma as the beneficiary will be allowed two years to sell and settle the property and not trigger CGT (section 118-195(1) of the ITAA 1997). (Alternatively, if sold and settled more than two years after Mrs Young’s date of death, the pre-CGT interest will be subject to CGT as normal – i.e. sale proceeds less cost base.)
The 50% interest in the property Mrs Young inherited from her late husband represents a post-CGT asset in her hands and is therefore subject to normal CGT rules. The cost base in Emma’s hands will represent the sum of the following:
- 50% of the market value of the property at the date Mrs Young passed away; and
- 50% of the market value of the property on 20 September 2018.
Assuming Mrs Young passes away on 6 January 2021 when the property’s market value is $800,000, then the resulting capital gain for Emma will be calculated as follows:
| $ | Notes | |
|---|---|---|
| Sale proceeds | 900,000 | 100% of sale proceeds, assuming Emma sells the property more than two years after Mrs Young’s date of death. |
| Less: Cost base | ||
| Post-CGT ownership interest inherited ($750,000 x 50%) | (375,000) | 50% of the property in Emma’s hands represents a post-CGT asset inherited from Mrs Young, cost base being the market value of the property at Mr Young’s date of death. |
| Pre-CGT ownership interest inherited ($800,000 x 50%) | (400,000) | 50% of the property in Emma’s hands represents a pre-CGT asset inherited from Mrs Young, cost base being the market value of the property at the date of Mrs Young’s death as noted above. |
| Equals: Gross capital gain | 125,000 | |
| Less: Capital losses | Assume nil in this example. | |
| Equals: Net capital gain | 125,000 | |
| Less: General 50% discount | Not applicable while owned as a non-resident. | |
| Equals: Assessable net capital gain | 125,000 | Assessable in Emma’s Australian tax return in the income year according to the contract sale date. Subject to tax at Emma’s non-resident marginal tax rates. |
Take home message
It is important to think of tax planning like preparing a will – consult with your accountant before an event occurs. Time is key and if you are well-informed beforehand, you can better reach your target position in the most tax effective manner achievable.
It is also important to remember that tax is only one of many other factors that requires consideration when making important financial decisions. Anticipated market movements, personal factors and economic factors also play a role. However, sometimes putting a number to the available options may make a decision easier to make.
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Disclaimer: This information is general in nature and should not be relied on as advice. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs and seek professional advice before making any decisions based on this information.
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