How a simple mistake cost this taxpayer $200,000 in inheritance

Good record-keeping has always been important when it comes to keeping on top of your tax affairs, and a recent dispute between the ATO and a taxpayer has demonstrated exactly why.

The taxpayer, one of four children, is set to lose 80 per cent of her inheritance because the tax office will not accept that she held the family home in trust for her parents.

With each child getting 25 per cent of the sale proceeds, this will leave the daughter an inheritance of only $50,250 after she pays the tax.Credit: AFR

Capital gains tax (CGT) legislation recognises that a property held by a trustee is considered the property of the beneficiary so can be covered by their main residence exemption.

However, the ATO decided that the daughter did not have enough proof that she held the house for her parents, further demonstrating the issue of tax law placing the burden of proof on the taxpayer.

The ATO can simply put its hands over its collective ears and say “we just don’t believe you”. And who can afford to fight the ATO all the way through the court system? You are guilty until you can prove yourself innocent.

Generally, family arrangements lack detailed documentation, but the only logical reason for the arrangement was that the daughter held the property in trust.

The ATO certainly received a lot more of her parents’ estate than the daughter.

Later in life, the parents decided to relocate from NSW, but they wanted to hold on to their NSW home for several years as other family members were living there. This meant they had to borrow to buy a home elsewhere.

Of course, the banks were not prepared to lend them money at their ages so they borrowed and bought the house in their daughter’s name. This property was the parents’ home from purchase to date of death, more than three decades later, their daughter only living there for a short while.

The parents paid all expenses relating to the home, including the loan repayments, eventually selling the NSW property to pay off the loan. The parents also spent a lot of their money improving their other home. Their wills made specific bequeaths of certain assets to particular beneficiaries, but the residual estate was to be split equally between their four children.

The capital gains tax on this property is significant because the property was purchased before August 20, 1991, so holding costs such as interest, rates and insurance cannot be included in the cost base.

It was 1991 when the government realised how inequitable this was: that a property could cost a person, in total, more than the sale proceeds, yet they would have to pay CGT on an imaginary gain created by poorly drafted legislation.

When the law was changed, it only applied to properties purchased after that date. Taxpayers were still trying to get their head around this very new law, not realising how far it reached into family arrangements, just a general understanding that the family home would not be subject to CGT.

It gets even worse because the parents paid for the improvements to the house – the cost of those cannot be included in the cost base of the CGT calculation because the “owner” (according to the ATO) did not pay for them.

After selling the house for $1 million, the capital gain comes out to $425,000, and the daughter will be left with a tax bill just shy of $200,000. With each child getting 25 per cent of the sale proceeds. This will leave the daughter an inheritance of only $50,250 after she pays the tax.

The ATO certainly received a lot more of her parents’ estate than the daughter. She was really quite lucky that the tax bill did not exceed her inheritance.

The ATO has declined to comment as it does not discuss individual taxpayer’s affairs.

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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