The ATO’s draft determination would mean people aren’t entitled to a capital gains tax exemption where their right to live in the home is through a testamentary trust. (Source: AAP/Getty)
Aussie families could face a “death tax” after inheriting a loved one’s home due to a fresh draft ruling from the Australian Taxation Office (ATO). Many wills use testamentary trust structures to manage and protect wealth, rather than distributing assets like the family home outright.
Currently, if you inherit the family home and later sell it, you can be exempt from capital gains tax in certain circumstances. One exemption is the main residence exemption, which applies if the surviving spouse or another beneficiary keeps living in the property.
Julie Abdalla, head of tax and legal at The Tax Institute, told Yahoo Finance the ATO’s new draft ruling proposed a “narrower interpretation” of when this exemption applies.
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“In particular, the ATO is focusing very closely on whether a person’s ‘right to occupy’ the home arises directly under the will itself, or whether it arises indirectly, for example, through a testamentary trust structure set up by the will,” she explained.
If it arises indirectly through a testamentary trust, the ATO’s draft ruling would mean capital gains tax would be triggered when the property is eventually sold.
A testamentary trust is established through a will and comes into effect after the death of the person who made the will.
Aussie lawyers and accountants have claimed such a change would effectively create a “death tax” on the family home.
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The Tax Institute’s Julie Abdalla has called on the ATO to reconsider its draft determination. (Source: The Tax Institute)
Importantly, Abdalla said this wasn’t a completely new tax but rather was about how the existing capital gains tax exemption was interpreted.
“A change to that interpretation could significantly affect outcomes for some families and trigger tax for which they may not otherwise have been liable,” she said.
That means Aussies could face a potentially significant tax bill, given how much property values have increased over time.
JBWere has estimated that $5.4 trillion in wealth will be transferred in Australia over the next 20 years. The vast majority of those inheritances will go to the partner if still in a couple (38 per cent) or the next generation if single (51 per cent).
It’s worth noting that you are exempt from paying capital gains tax on an inherited property if you sell it within two years. If you don’t sell it within two years, the main residence exemption could come into play.
Abdalla said the most likely Aussies that would be impacted include:
surviving spouses living in a home held through a testamentary trust;
children or other beneficiaries who continue to occupy the property;
families with blended family arrangements; and
estates structured for asset protection using trust mechanisms.
A key concern The Tax Institute has with the draft ruling is the uncertainty it brings for taxpayers.
“Two estates with very similar facts could face different tax outcomes simply because of how the will was drafted, not because the family’s intentions were different,” Abdalla said.
The ATO has not yet released its final ruling on the proposed interpretation and The Tax Institute is urging it to reconsider.
The Institute has argued that the draft ruling places “disproportionate emphasis” on the technical drafting, rather than the rights created by a will.
“Where a will clearly provides for a person to live in the family home, the tax outcome should not depend on whether that right is expressed directly or arises through a testamentary trust structure,” Abdalla said.
Testamentary trust structures have been used for decades based on advisers and families believing the exemption would apply. If this changes, the Institute warned there would be “widespread unintended consequences”.
Abdalla said the main residence exemption for deceased estates was designed to provide continuity and sensible outcomes for families during a vulnerable time.
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