If you are inheriting an investment property in Australia, the tax story is not the one most people expect. There is no inheritance or estate tax in Australia. What there is instead is capital gains tax waiting at the point the property is sold or otherwise disposed of, and income tax applying as usual to any rental income it earns along the way.
This guide covers the tax side of an investment property passing on death: the two-year rule that can extinguish the gain entirely, and what happens if the property is kept and rented. It also covers how the CGT discount is measured for an inherited asset, and the situations where the exemptions narrow or fall away. It does not cover estate administration or the legal steps of transferring a title to a beneficiary.
No inheritance tax, but the tax does not disappear
The absence of an inheritance tax is the headline, and it is genuine: you do not pay a tax simply because money or assets came to you from someone who died. The obligations attach differently. Capital gains tax may apply when you dispose of an asset inherited from a deceased estate, and income tax applies as usual to dividends or rental income from shares or property you inherited.
The estate itself can also generate tax along the way. Until the deceased person's estate is finalised, it may keep earning income, from a rental property or other investments for example. If you become presently entitled to income of the estate, you need to include it in your tax return, and the legal personal representative of the estate should give you the information you need to lodge it.
The two-year rule
This is the provision most families end up asking about. Disposing of the property within two years of the death meets the exemption requirement, and the counting is specific: you dispose of the property under a contract that settles within two years of the deceased's death. It does not matter whether the property was used as a main residence or to produce income during that two-year period.
The same exemption is available if you are the trustee of the deceased estate rather than a beneficiary.
The ATO's own worked example shows how it lands in practice. Petro inherited his father's house, rented it out, and disposed of it 15 months after his father died. Because he acquired the house after 20 August 1996 and disposed of it within two years of the death, he was entitled to a full exemption from CGT.
If the two years are about to lapse and the sale has not happened, the Commissioner has discretion to extend the period for CGT events, such as a sale, happening in the 2008–09 income year and later years.
If you do not sell within two years
Missing the two-year window does not automatically mean the gain is fully taxable. The second route to the exemption runs through the property's status. From the deceased's death until you disposed of your ownership interest, the dwelling was not used to produce income and was the main residence of one or more of the people the ATO's conditions cover. The exemption can also cover a period after the deceased stopped living in the dwelling. It covers that period indefinitely if the dwelling was not used to produce income after they stopped living in it, or a maximum of six years after they stopped living in it if it was rented out after they moved.
When the exemption narrows or disappears
A few conditions sit around the exemption.
The exemption covers the dwelling, and the dwelling has to go with what surrounds it. The inherited property must include a dwelling and you must sell them together; generally, you cannot get a CGT exemption for land or a structure sold separately from the dwelling.
Residency matters too. If the former owner was a foreign resident for more than six years at the time of their death, you cannot claim the main residence exemption for the period they owned the property. If you have been a foreign resident for more than six years when you sell, you cannot claim it for the period you owned it. If you have been a foreign resident for six years or less at the point of sale, you must satisfy the life events test to claim it.
The structure of the estate changes the picture as well. Where a CGT asset passes to a tax-advantaged entity, such as a charity or a super fund, CGT applies to the deceased at the time of their death.
If you keep the property and rent it out
Plenty of beneficiaries hold an inherited investment property rather than selling, and the tax then runs on two tracks.
The income track is the ordinary one: rental income is taxed as usual.
The gains track is where inherited property behaves differently from any other asset you own. Australian resident individuals, trusts and super funds can use the CGT discount to reduce a capital gain on assets owned for 12 months or more. For that ownership test, you can treat an inherited asset as though you have owned it since the deceased died, if the deceased acquired it before 20 September 1985. If the deceased died before 21 September 1999, there is an alternative: indexing the cost base for inflation up to 21 September 1999 instead of using the discount, which treats you as having acquired the asset when the deceased acquired it.
Working out the gain itself starts with the cost base. Unless the asset you inherit is fully exempt, you need its cost base to calculate CGT when you sell, and depending on the circumstances that cost base may be based on the value of the asset when the deceased acquired it. One thing you cannot carry over: if the deceased had any unapplied net capital losses when they died, those losses do not transfer to you as a beneficiary, so they cannot be used to offset your gains.
The arithmetic is also on you in a literal sense. The standard CGT calculator and record keeping tool cannot be used for inherited assets from a deceased estate, so you need to calculate the CGT yourself; the ATO publishes a summary fact sheet of common scenarios, Capital gains tax on inherited property, NAT 75356.
Where PropSpotter fits
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