The capital gains tax implications of selling an inherited property

Inheriting a property is usually seen as a once-in-a-lifetime windfall, but when it comes to selling it, it’s important to be aware of the complications capital gains tax (CGT) can bring.

Generally speaking, when properties have only been used as a principle place of residence, no CGT is applied to the sale proceeds. This rule is also applicable to properties bought before September 20, 1985, regardless of how the property was used.

But tax implications arise when dealing with houses that aren’t being sold by the now-deceased owner, but have been inherited and are being sold by the beneficiaries.

Capital gains tax on inherited properties

Financial expert Jim Kilkenny says one of the most important things to consider when trying to minimise CGT is the timing of the sale.

“In a nutshell, where the executor of the estate or the beneficiaries sell a property which was used exclusively as a principal place of residence by the deceased, there will be no capital gains tax on the sale so long as it is sold within two years of the death of the owner,” he says.

However, this rule only applies if the house was exclusively a principal residence for the deceased and was not let or otherwise used commercially during the two years subsequent to their death, meaning if any income was made from the property, no matter how big or small, proceeds of the sale may be only partially exempt from CGT.

According to the ATO, partial exemption can include properties that were the main residence for only part of the time from when it was initially acquired by the deceased up until the point of sale. The exempt proportion of the capital gain can be calculated by taking the time period of main residence and dividing it by the total time of ownership. And for properties acquired by the deceased before September 20, 1985, the relevant period starts at the date of death.

Special circumstances for sales

Although selling a property in the two years after it is inherited is the general rule of thumb for minimising CGT, certain situations can call for an ‘application of extension’, which means you can sell the property more than two years after inheritance with the same CGT status. But such an extension must be approved by the ATO.

These situations include delays that are out of your control, such as:

• the ownership of a dwelling or a will is challenged
• the complexity of a deceased estate delays the completion of administration of the estate
• a trustee or beneficiary is unable to attend to the deceased estate due to unforeseen or serious personal circumstances arising during the two-year period (for example, the beneficiary or a family member has a severe illness or injury)
• settlement of a contract of sale over the dwelling is unexpectedly delayed or falls through for
• circumstances outside the beneficiary’s or trustee’s control.

Think carefully about CGT implications

So what happens if you missed the two-year period and don’t have a valid reason to apply for an extension, or are choosing to keep the property for longer? Kilkenny says CGT will be based off the value and use of the house following the change of ownership – so think carefully before renting it out or listing it on AirBNB

“If the deceased acquired the property prior to the 20th of September, 1985, the beneficiary will only be subject to capital gains tax – if the property is not used by them as a principal place of residence – on capital gains arising after the death of the previous owner,” he explains.

But if the beneficiary continues to use the property as their own principle place of residence, as did the deceased, the deceased owner’s exemption from CGT will carry over. The same applies if the property was used exclusively as a principal place of residence by the deceased up to their date of death.

“It is very important then for executors and beneficiaries to get a formal valuation of such a property at the date of death if it is not being sold within two years of the date of death of the deceased,” Kilkenny notes.

CGT will apply if the property is transferred to a tax-advantaged entity such as a charity or to a foreign residence. It’s also important to note that any unapplied net capital losses from the deceased will not transfer to the beneficiary to offset against any net capital gains.