In Australia about $3.5 trillion in assets will likely change hands in 2050, according to a 2021 research paper by the Productivity Commission. Most of this will be inherited by family beneficiaries. Given the amounts involved estate planning should be undertaken to avoid unwanted tax bills.
A simple example can show how estate planning could potentially prevent an unwarranted CGT liability arising.
Assume a 30-acre block of land on one title is owned by a couple, Anna and Barry. The land, originally purchased in 1987 for $100,000 has been used by their family for holidays over the past 40 years. An old shack is on the land and usually the various family members pitch tents to ensure they can all be accommodated.
Looking back on how much each of their children enjoyed the family holidays, Anna and Barry prepare their wills leaving the land to their 3 children, Camilla, Daniel and Eliza.
Anna and Barry then die, and the land becomes jointly owned by the three children. While Anna and Barry hoped the land would stay in the family forever, each of the children have different ideas on what they should do with it. Camilla has plenty of spare cash and wants to build a substantial holiday house on her share of the land. Daniel wants the cash to renovate his main residence so is keen to sell his share. Eliza also wants to sell so she can enjoy an early retirement and travel the world. The land is now worth $1 million.
Is it as simple as them choosing their preferred 10 acres? Presumably Daniel and Eliza will be subject to CGT if they sell their share of the land? Are there any implications for Camilla who is keeping her share of the land?
Unfortunately, even a simple situation like this does not have a simple outcome. The CGT implications for each of them will depend on how and when the subdivision takes place, and whether each of the subdivided blocks are the same value. Consider these different scenarios:
- The land passes to Camilla, Daniel and Eliza under the will and then they subdivide into 3 lots of 10 acres each.
- Anna and Barry subdivide the land into 3 separate titles and then prepare a will leaving 1 title to each of Camilla, Daniel and Eliza.
- Anna and Barry’s wills direct the executors of the estate to subdivide the land prior to distributing the separate titles one to each of the 3 beneficiaries.
Land passes to Camilla, Daniel and Eliza and then they subdivide
The unsubdivided land passes to Camilla, Daniel and Eliza via the will, with them each owning a 1/3 share of the 30 acres. Under Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997), the beneficiaries pick up the cost base of the land. As the land was owned for over 35 years, the capital gain is significant.
Camilla wants to keep 10 acres, and Daniel and Eliza want to sell the remaining 20 acres. Unfortunately for Camilla, they each own a 1/3 share of the entire 30 acres, which is different to each of them wholly owning 10 acres. So, if Camilla wants to keep 10 acres, for CGT purposes she is disposing of 1/3 of the 20 acres and acquiring 2/3 of the 10 acres she is keeping. This means that even if she is keeping her share of the land, she has a CGT liability in respect of the 1/3 disposal of the other 20 acres. With a capital gain of the entire land being approximately $900,000, she is looking at a capital gain of $200,000, being 2/3 of her 1/3 share. Although the 50% CGT discount will be available, it still leaves a significant income tax impost.
On a positive note, Camilla will get a step up in cost base to the market value for the 2/3 of the 10 acres she acquired from her siblings, although any benefit will only be realised when she sells the property in the future.
Daniel and Eliza will be disposing of their shares of the land, partly to Camilla in relation to the 10 acres and the other 20 acres to a third party. As expected, Daniel and Eliza will be subject to CGT on the disposal and will be entitled to the 50% CGT discount, although this may arise in two parts. Firstly, they will have the same CGT outcome as Camilla as the titles are separated; then on the ultimate sale to a third party they will realise the balance of their capital gain.
Anna and Barry subdivide the land and then prepare the will
Alternatively, although Anna and Barry want their 3 children to jointly own the land and continue to enjoy it for years to come, they realise that their children have different financial positions and may possibly have different views on whether or not to keep the property.
To ensure they minimise any tax consequences and to give their children more flexibility to make decisions independent of each other, Anna and Barry decide to subdivide the property into 3 separate blocks while they are still alive.
As there is no disposal of the land and no change in beneficial interests, no CGT event arises on the subdivision. According to section 112-25 of the ITAA 1997 the cost base of the original asset is apportioned in a reasonable way to each new asset. Assuming the land is split equally (and ignoring any value of the shack), the cost base of each block will be $33,333.
Each child is then entitled to one block under the will, e.g., Block 1 for Camilla, Block 2 for Daniel and Block 3 for Eliza. They can each do what they like with their own block, and there will be no implications for the other siblings. Compared with scenario 1 above, if Daniel and Eliza dispose of their blocks they have the same outcomes as in scenario 1, but there are no CGT implications for Camilla.
Executors subdivide the land
It may be possible for the Executors to subdivide the land prior to distributing the land to the children. The land could be subdivided into the 3 blocks, with each beneficiary receiving one block.
However, the above is a relatively simple scenario. What if there are more family members, and more assets? Is the cost of subdividing going to be covered by the Estate, or does it only come out of the inheritance of those particular beneficiaries? Administering an estate is not always easy, and the executors might not want the additional complexity of undertaking a subdivision. Could it lead to disputes?
What if they decide to keep the land but prefer to subdivide so each have their own title?
Camilla, Daniel and Eliza might be happy to keep the land. But they might have different ideas on what they will use it for. Similar to the above, Camilla might want to build a house, but Daniel and Eliza might be wanting to continue pitching tents. Although the 3 siblings have a good relationship, it would be recommended that Camilla builds the house on her own land, not land jointly owned with Daniel and Eliza. So again, they choose to subdivide into Blocks 1, 2 and 3.
In this case, no one is disposing of the land. However, CGT will still apply with deemed market value proceeds applying to work out the capital gain. Camilla is disposing of her 1/3 share of Blocks 2 and 3, Daniel is disposing of his 1/3 share of Blocks 1 and 3, and Eliza is disposing of her 1/3 share of Blocks 1 and 2. In this situation, all 3 of them have a CGT liability even though to all intents and purposes they still each own 1/3 of the land.
Transfer duty implications
Then there is the question of transfer duty. Concessions should apply on a partition of land similar to that described above. If we look at the Victorian legislation, there is a concession that applies where the Commissioner is required to reduce the value of the land by the value of the beneficial interest in the land held by the transferee before the transaction. This concession ensures that there is no duty payable provided the value of the transferee’s interest in the partitioned property does not exceed the value of the transferee’s interest in the property prior to the partition. If the value of the partitioned land does exceed that amount, stamp duty is assessed on the difference between the value of the original interest and the value in the partitioned property. So, if the 3 lots are the same value, in theory transfer duty should not arise. If there is a difference between the 3 lots, then there will be stamp duty payable on the difference. For example, if Camilla’s lot was worth $400,000 with the other 2 blocks worth $300,000 each, Camilla would be subject to transfer duty on $66,667, being $400,000 less $333,333.
A valuation is required in order to obtain the concession. The Victorian SRO website says the valuation can either be a letter of appraisal from a licenced real estate agent and a copy of the rate notice or a valuation from a certified practicing valuer. Given that there are also CGT implications, it would be preferable to obtain a valuation from a certified practicing valuer as that is the standard the ATO would usually expect for CGT purposes.
Based on the above, we can see its best for property issues such as the above to be dealt with prior to or when drafting the will. Importantly, this example shows the need to obtain legal advice when doing a will as a lawyer should point out potential issues that need to be considered and taxation advice can be sought where appropriate.