Tax with Max: Working out CGT complications

Calculating capital gains tax on a property when the situation involves an inheritance, a rental arrangement and a subdivision.

Summary: A number of capital gains tax principles apply to real estate. When someone lives in a house until their death, if the property is sold and settled within two years of the date of death the main residence CGT exemption applies. When a property was purchased before September 20, 1985, and is sold and settled within the two-year period, there is no CGT in most circumstances. The act of subdividing a property creates a new asset for CGT purposes and results in tax being payable.

Key take-out: If a property is inherited and then subdivided, CGT can be payable on the new asset. In complex situations, seek professional advice.

Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Working out CGT complications

My grandmother bought her house and land in the 1960s. She moved into a nursing home in 2006. Her granddaughter and partner moved into the house in 2006 under a private rental agreement paying $600 per month, which was used to pay nursing home fees. Grandmother died in February 2014 leaving the home to her son and his wife.

The property was valued at $560,000 at the date of her death. The plan is to subdivide the property with the 50 per cent being vacant land sold to her granddaughter and partner for $100,000. The market value of the vacant block is between $140,000 and $160,000. The son will then sell the other half of the block with the house at market value.

What are the capital gains tax implications for the son and his wife with regard to the vacant block being sold to the daughter, and the half of the block that has the old home on it? My understanding would be that no CGT applies to either of the sales as long as they are settled by February 2016 because it is a pre September 1985 property and sold within 2 years of death, regardless of it being a rental property since 2006.

Answer: There are number of capital gains tax principles that apply to the property. The first, as you have identified, relates to property inherited being classified as the main residence of the grandmother at the time of her death.

Under normal circumstances where a person lived in a house up until the time of their death there is no doubt that the property was their main residence. In this situation as long as the property is sold and settled within two years of the date of death the main residence CGT exemption applies and no capital gains tax would be payable by whoever inherited it.

Since the 2008-2009 financial year the commissioner of taxation has had a discretion to extend the two-year limit with regard to classifying a property as the main residence. To obtain this discretion a compelling case would need to be put to the commissioner based on circumstances beyond the control of the executor of the estate.

A property can still be regarded as a main residence even though the owner was not living in it at the time of their death. This can be the case when the owner of the property has moved into a nursing home. For this situation to apply the property cannot have been used to produce income after the deceased stopped living it.

The only exception to this is if the person did not have another main residence, as would have been the case in this example as the grandmother moved into a nursing home, but the exemption only lasts for a maximum of six years after the owner has ceased occupancy when it is used to produce income.

In a situation where the granddaughter rented the property from 2006 the main residence exemption would not apply.

The other CGT principle that applies is where a property was purchased prior to the introduction of the CGT system on September 20, 1985. In most circumstances when a person inherits a property that was purchased before that date there is no tax paid on any capital gain, as long as it is sold and settled within the two-year period.

This exemption applies even when the property is not lived in by the person who inherits it or the property is used to produce income during the two-year period. If the property is not rented the two-year period can be extended if the house was occupied by a spouse of the deceased immediately after their death, or an individual has a right to live in the home as a result of the deceased’s will.

There is however another CGT principle that applies to this property as a result of it having been subdivided. The act of subdividing a property creates a new asset for CGT purposes and would result in tax being payable on the portion of the land sold to the granddaughter.

This means that capital gains tax would be payable on the difference between the market value of the land sold to the granddaughter and the value of the land at the date of the grandmother’s death. The tax act allows taxpayers to calculate the value of the land as long as it is done on a reasonable basis. A reasonable basis often only requires the taxpayer to have based their calculations on factual information such as sale results.

I stated that capital gains tax would be payable on the difference between the estimated value of the block at the date of death and the market value at the time of the sales of the granddaughter. This is because under income tax law if anything is sold for less than market value that sale price is ignored and the CGT calculation is based on the market value at the time it is sold.

If someone had the property valued at the date of the grandmother’s death the valuer should be able to put a value on that part of the original property that had the home on it, and the part of the property that became vacant land that will be sold to the granddaughter.

To arrive at the cost of the subdivided land the costs of subdivision are added to the market value of each of the resulting blocks. If the subdivision costs had been $10,000, and the costs related equally to both of the blocks, $5000 would be added to the market value of the blocks at the date of death.

Assuming that the vacant land had a market value of $120,000 at the time of death, the share of the subdivision costs was $5000, and the market value for the sale of the land to the granddaughter was $150,000, a gain of $25,000 would be made with 50 per cent included in the assessable income of the son and the daughter-in-law.

As long as that part of the property containing the former home of the grandmother is sold and settled within the two-year period, no capital gains tax should be payable on any profit made on its sale.

As you can see the situation outlined in your example is extremely complicated when it comes to assessing the capital gains tax implications of what is happening. You should seek professional advice from an accountant that specialises in this area before taking any action.


Max Newnham is a partner with TaxBiz Australia, a chartered accounting firm specialising in small businesses and SMSFs. Also go to www.smsfsurvivalcentre.com.au.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Do you have a question for Max? Send an email to askmax@eurekareport.com.au.