The most basic tax trap when you have more than one heir

It is as simple as leaving a parcel of shares to your children, and the ATO becomes a beneficiary of your estate.

Let’s say, for example, you have 10,000 BHP shares that you purchased for $10 each, and they are now worth $40. Your will says that they are to be distributed to your two children, Jack and Jill. So the executor simply transfers the ownership of this parcel into the names of Jack and Jill. There is a rollover relief that ensures this transfer is not subject to capital gains tax (CGT), and if you purchased the shares after September 19, 1985, Jack and Jill carry over your cost base as the cost base on their jointly held shares.

The ATO can become a beneficiary of your estate when you leave a parcel of shares to more than one heir.Credit: Tamara Voninski

Jack needs to sell his shares, but Jill wants to continue to hold hers, collect the dividends and avoid the CGT on sale. To do this, Jill must transfer her half-ownership in half of the shares to Jack and Jack needs to transfer to Jill half of his ownership in half of the shares. As this is a non-arms-length transaction, it is deemed to happen at market value. That is a $30 capital gain for half of the portfolio, the 50 per cent discount will apply because you, the deceased, owned the shares for more than a year.

So now Jack has 5000 shares, 2500 of which have a cost base of $10 and 2500 a cost base of $40. It all comes out in the wash for Jack, as this simply means he pays the same amount in CGT just over two transactions. But Jill has had to pay CGT on 2500 x $30 less the 50 per cent discount without receiving any cash proceeds, and she still owns only half of your parcel of 10,000 BHP shares.

Jill’s tax bill could have been avoided if the will simply said, I give 5000 of my BHP shares to Jack and 5000 of my BHP shares to Jill. That is it, just the right wording, that is all it takes. Jill still has the $10 cost base per share, but if she never sells, she never pays the CGT.

Even if neither child wanted to sell, it is very likely they would want to hold their share of the parcel in their own name. After all, the default position is joint tenancy, so in the event of one of them dying, the other will become the sole owner of all the shares. Arranging for individual ownership will trigger a CGT event at market value on half of each share. The ATO gets to tax the $30 gain on half the portfolio even though there are no sale proceeds.

If you find yourself on the receiving end of a poorly planned will, before ownership is transferred, seek legal advice about the beneficiaries entering into an agreement to change the way the assets are distributed, but be careful. If, for example, Jill were to say she wanted all the BHP shares and would pay the estate $40 x 5000 = $200,000 for the other half the estate can then pay out Jack. She could be considered for CGT purposes to have purchased the whole parcel from the estate at market value and trigger a CGT event on all 10,000 BHP shares. The rollover that allows the shares to be transferred to beneficiaries without triggering CGT would be completely lost.

Julia Hartman founded BAN TACS Accountants more than 30 years ago and is still passionate about all things tax.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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