Dollars & Sense: When capital gains tax applies on an inherited home
Our financial adviser looks at when capital gains tax applies to inherited properties, while a reader asks about reducing mortgage repayments to buy shares.
If I inherit my parents’ home, their principal place of residence, will I have to pay capital gains tax if I sell the property?
Vincent, Melbourne
In a rising housing market, receiving a property can be a blessing or a drain on your finances depending on its condition. The outcome may also depend on whether it is inherited with siblings who may be in a different position to each other, and have different plans and needs.
The outcome may also depend on whether you wish to live in the property, keep the property as a rental, or sell the property.
If the property has always been your parents’ principal place of residence, that is, not rented out for any period of time, then technically it should meet the principal place of residence 100 per cent exemption, which means there are no capital gains issues providing you meet the “two-year rule”.
The two-year rule states you must dispose of the property within two years to avoid any capital gains tax. You can apply for an extension, but only under certain circumstances will that be granted. You can check the ATO website for more information.
There are some scenarios where the property may still be eligible for capital gains tax exemption if it met certain criteria, but you would need to seek advice. The easiest scenario for 100 per cent exemption is if it has never been rented out.
If you keep the premises unoccupied and/or keep it as a rental property, after two years you will incur capital gains tax when you sell. The cost base is the value of the property at the date of death, not the value after two years.
To give you the option to manage capital gains tax in the future you could consider receiving it in a testamentary discretionary trust, but you would need specific advice about the pros and cons of doing so from an estate planning expert as this may not be beneficial until after the two years. And your parent must have requested in their will that a testamentary discretionary trust be established.
Should I cut my home loan repayments to buy shares?
I have a mortgage but no investments. Should I reduce my mortgage repayments to buy shares?
Jason, Hobart
The benefit of shares is that they are liquid, so if you need funds, you can access them. Shares are two dimensional – they provide capital growth and dividend income. You can take this income or you can reinvest it. Either way, this is income and is therefore taxable.
If you have superannuation you are likely to be invested in a managed fund (a composition of shares) and the tax rate is 15 per cent, likely to be much lower than your marginal tax rate. But superannuation also comes with limited access unless you are of a certain age or retired.
The mortgage itself, the interest that you pay, is likely to be non-tax deductible interest if it is for your principal place of residence. If you borrow against the property, using equity to invest in shares, that portion of borrowings becomes tax deductible.
Consideration needs to be given to what is the purpose of investing in shares? What is the timeframe? What goal are you trying to achieve? Are shares the right strategy? What structure should they be in – own name, partner name, joint name, trust, super, age? Should these be using borrowed funds? How much equity do you have? What role will tax play? What if interest rates go up? Do you have all your five foundations in place to ensure you are not forced to sell in a down market?
It’s a great question, with a classic “it depends” answer, sorry! Lots to consider here, definitely worth seeking advice from a licensed financial adviser before proceeding.
Helen Baker is a licensed Australian financial adviser and author of Money For Life: How to build financial security from firm foundations. Follow her at @onyourowntwofeet.
The responses provided are general in nature, and while they are prompted by the questions asked, they have been prepared without taking into consideration all relevant circumstances. Before relying on any of the information, please ensure that you consider the appropriateness of the information provided with regard to your objectives, financial situation and needs, and seek independent professional advice.
Welcome to our Dollars & Sense column. While in no way is it formal financial advice, it is a way to stress test your decision-making, to find out potential financial implications before you make your choice, and to discover more about structuring your affairs so that your money works harder for you. Submit your questions to dollarsandsense@theaustralian.com.au.