Introduction
In Australia, the taxation of estates and the implications of capital gains tax (CGT) on inherited assets are pivotal considerations in estate planning. When a family member passes away, the executor of the deceased estate is responsible for managing the estate's assets, which includes the potential sale of assets such as property as well as paying income tax on income earned while the estate is being administered. At this time the Executor or Administrator of the estate is treated as the trustee of the estate trust and taxed accordingly - unless a beneficiary is presently entitled to any income. For trust estates the following applies - according to the ATO:
First 3 income years
Normally, a trustee who is assessed on the net income of a trust pays tax at the top marginal tax rate.
When you lodge your first trust tax return for the deceased estate, you can apply for a concessional rate of tax.
The concessional rate is the same as the individual income tax rates, with the benefit of the full tax-free threshold.
The concessional rate will apply for the first 3 income years of the deceased estate, unless there are material changes to the estate's circumstances.
Deceased estates do not get the benefit of tax offsets (concessional rebates), such as the low-income tax offset. No Medicare levy is payable.
You cannot extend this concessional period beyond the first 3 income years.
Example – first 3 income years
Joan passed away on 5 April 2023.
The first income year for Joan's deceased estate is 6 April 2023 to 30 June 2023.
The second income year is 1 July 2023 to 30 June 2024.
The third income year is 1 July 2024 to 30 June 2025.
If Joan's deceased estate earned taxable income of $18,200 or less during these years, there is no tax payable.
There are different rules post the first three income years which can be found here: https://www.ato.gov.au/individuals-and-families/deceased-estates/doing-trust-tax-returns-for-the-deceased-estate/tax-rates-deceased-estate
Capital Gains Tax
If the executor sells an inherited asset, any capital gain is subject to income taxation. The tax is calculated based on the difference between the asset's cost base (usually the purchase price plus costs associated with acquiring, holding, and selling the asset) and the sale price and a 50% discount is applied. The estate is taxed on this discounted capital gain at the adult marginal tax rates applicable to the income of the estate in the first three income years as noted above.
Comparatively, if the asset, such as a property, is passed directly to a beneficiary, such as an adult child, and they decide to sell it later, they are responsible for paying CGT on any capital gain. The calculation of the gain will consider the asset's cost base at the time it was originally acquired by the deceased and the sale price when the beneficiary sells the asset. For a high-income beneficiary paying tax at the top marginal rate of 47%, this can result in a significant tax liability, especially if the asset has appreciated substantially.
Case Study
An executor sells an estate property purchased by the deceased for $300,000 and now worth $1 million, the estate would include a discounted $350,000 capital gain in its trust income tax return. The taxation will be at individual tax rates in the first three years as noted above.
If, however, the property is passed to a high tax rate paying adult beneficiary who sells it a year later for the same price, the CGT calculation would similarly be based on a discounted $350,000 capital gain, but the tax would be at the beneficiary's personal tax rate of 47%, assuming they have no other deductions or offsets to apply against the gain.
This comparative case study underscores the importance of strategic estate planning and the need for professional advice. Engaging with estate planning lawyers and tax specialists, such as those at Abbott and Mourly Lawyers, can provide crucial guidance on how to structure an estate to minimise tax liabilities and ensure assets are distributed according to the deceased's wishes. These professionals can offer tailored advice on navigating the complexities of estate taxation, CGT implications, and the benefits of various strategies, such as whether to sell an asset through the estate or transfer it directly to beneficiaries. Their expertise can help executors and beneficiaries make informed decisions that align with their financial goals and tax planning objectives, ultimately ensuring a smoother and more tax-efficient estate administration process.