Private ruling: Main residence exemption
Date of advice: 8 March 2018
Published: June 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the main residence exemption apply to disregard the capital gain made upon disposal of the property by the deceased’s estate? | A1: Yes

Relevant facts and circumstances: The deceased’s spouse acquired the property before 20 September 1985. The property was the main residence of the deceased’s spouse and the deceased from the time of acquisition. The deceased’s spouse died in late 19XX and left the property to the deceased. Probate was granted to the deceased in early 19YY. The property’s title was not transferred to the deceased in either their capacity as executor or beneficiary. The deceased continued to live in the property as their main residence after their spouse’s death until late 20XX, when they moved into a nursing home. The property was not used to produce assessable income. The deceased died in early 20YY. The deceased left the property to their children in their will. Probate was granted appointing Child A as Executor in late 20YY. The property sold in late 20ZZ, with settlement scheduled to occur in late 20ZZ. Child A died in late 20ZZ. Child B applied for Letters of Administration De Bonis Non and was appointed administrator of the deceased’s estate in early 20AA. The property settled in early 20AA.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 128 | Income Tax Assessment Act 1997 section 128-10 | Income Tax Assessment Act 1997 section 128-15 | Income Tax Assessment Act 1997 section 128-20 | Income Tax Assessment Act 1997 section118-195 | Income Tax Assessment Act 1997 section118-145

Reasons for decision: Summary: The deceased became absolutely entitled to the property at the time probate for their deceased spouse’s will was granted. We consider the property ‘passed’ to the deceased under section 128-20 of the Income Tax Assessment Act 1997 (ITAA 1997) at the granting of probate and became part of their estate after their death. The property that was sold within 2 years of the deceased’s death, was acquired after 20 September 1985 and was the deceased’s main residence at the time of their death, therefore the main residence exemption may apply to disregard the capital gain made upon the disposal of the property by the deceased’s estate. | Detailed Reasoning - Detailed reasoning: Capital gains tax and deceased estates Generally, you can disregard a capital gain or capital loss made on the transfer of an asset from a deceased taxpayer’s trustee/executor to a beneficiary when the asset passed to the beneficiary. A CGT asset owned by a deceased person at the time of their death passes to a beneficiary of the deceased‘s estate if the beneficiary becomes the owner of the asset if the legal ownership in the asset is transferred to them, or if the beneficiary becomes absolutely entitled to the asset as against the trustee/executor. On the death of a taxpayer, the property of the deceased passed to their estate, legal control of which is exercised by an executor of legal personal representative (LPR). A fiduciary obligation is assumed by the executor/administrator on the death of the taxpayer in favour of the beneficiaries of the estate. At that time, the beneficiaries of the estate have no interest in the assets of the estate, although they do have a beneficial interest to see that the estate is properly administered. Even though a will may provide beneficiaries with absolute or indefeasible interest in the assets of an estate, under state laws those interests cannot crystallise until probate has been granted. Absolute entitlement The main CGT provisions to which the concept of absolute entitlement is relevant apply if a beneficiary is (or becomes) absolutely entitled to a CGT asset of the trust against the trustee (section 106-50 of the ITAA 1997). The provisions apply separately to each beneficiary and asset of the trust. They require absolute entitlement to the whole of a CGT asset of the trust. Paragraph 72 of Taxation Ruling TR 2004/D25 states that: A beneficiary of a deceased estate does not have an interest in any asset of the estate (and therefore cannot be considered absolutely entitles to any of the estate’s assets) until the administration of the estate is complete. That is, until the assets of the estate have been called in and the deceased’s debts and liabilities have been paid. Commissioner of Stamp Duties (Qld) v. Livingston [1965] AC 694; [1964] 3 All ER 692. Taxation Ruling IT 2622 confirms that the beneficiaries of a deceased estate become beneficial owners of the assets of the deceased after the estate is fully administered (therefore not until probate is granted). At paragraph 2 it provides: On the death of a taxpayer, the property of the deceased taxpayer passes to his or her estate, legal control over which is exercised by an executor or administrator. The executor or administrator, in effect, steps into the shoes of the deceased and winds up the deceased’s personal affairs. An executor of a deceased person who leaves a will must obtain probate of the will. This is the official proving of the will and provides the executor with the authority to deal with the estate. ….” Division 128 of the ITAA 1997 – Effect of death General rules regarding capital gains (or losses) as a result of death are covered under Division 128 of the ITAA 1997. According to section 128-10 of the ITAA 1997 any capital gain or capital loss resulting from a CGT event in relation to an asset owned by the deceased person immediately prior to the time of death is disregarded. Section 128-15 of the ITAA 1997 provides that if a CGT asset owned by the deceased immediately prior to death devolves to the LPR or passes to a beneficiary of the estate, the LPR and the beneficiary is deemed to have acquired the asset on the date of death of the deceased owner. Any capital gain or capital loss made by the LPR when the asset passes to a beneficiary is also disregarded (subsections 128-15 (2) & 128-15(3) of the ITAA 1997). Subsection 128-20(1) of the ITAA 1997 provides that an ‘asset passes to a beneficiary’ if the beneficiary becomes the owner of the asset: a) under the will of the deceased person or that will as varied by a court order; or b) by operation of an intestacy law, or such other law as varied by a court order; or c) because it is appropriated to the beneficiary by the LPR in satisfaction of a pecuniary legacy or some other interest or share of the estate of the deceased; or d) under a deed of arrangement. The section also states that it does not matter whether the asset is transmitted to the beneficiary directly or through the LPR. Taxation Determination TD 2004/3 provides that an asset will ‘pass’ to a beneficiary of a deceased estate under section 128-20 of the ITAA 1997 if the beneficiary becomes absolutely entitled to the asset against the estate’s trustee (whether or not the asset is later transmitted or transferred to the beneficiary). While it is clear that an asset has passed to a beneficiary once legal ownership of the asset has transferred to the beneficiary, we consider that an asset can pass to a beneficiary prior to transfer if the beneficiary becomes absolutely entitle to the asset against the trustee. It is considered that there is nothing in section 128-20 of the ITAA 1997 that makes ‘passing’ dependent upon the acquisition of legal ownership. Deceased estate – main residence exemption Subsection 118-195(1) of the ITAA 1997 states that if you own a dwelling in your capacity as trustee of a deceased estate (or it passed to you as a beneficiary of an estate), then you are exempt from tax on any capital gain made on the disposal of the property if: ● the property was acquired by the deceased before 20 September 1985, or ● the property was acquired by the deceased on or after 20 September 1985 and the dwelling was the deceased’s main residence just before the deceased’s death and was not then being used for the purpose of producing assessable income, and ● your ownership interest ends within 2 years of the deceased’s death (the Commissioner has discretion to extend this period in certain circumstances). You have an ownership interest in a property if you have a legal interest in the property. This means that if you sell a property, your ownership interest continues until the date of settlement (rather than the date the contract of sale is signed). If a dwelling ceases to be an individual’s main residence, the individual may choose to continue to treat it as their main residence under section 118-145 of the ITAA 1997 if: ● the dwelling is not being used to produce assessable income, it may be treated as the main residence indefinitely; and ● the dwelling is being used to produce assessable income, the maximum period during which this choice may apply is 6 years. If the choice is made, the individual may not claim the main residence exemption for any other dwelling. | Detailed Reasoning - Application to your circumstances: In this case, the deceased was the sole beneficiary of the property and executor of their deceased spouse’s estate. The deceased obtained probate, however they failed to affect the transfer of legal ownership of the property prior to their death. As discussed above in TR 2004/D25 and IT 2622 and TD 2004/3, a beneficiary of a deceased estate cannot become the owner of assets of the deceased until probate is granted. As probate was granted and the deceased was the sole beneficiary of the property under their deceased spouse’s will, we consider that they became absolutely entitled to the property at the time probate was granted. Although legal ownership of the property did not pass to the deceased prior to their death, we consider that the property passed to them under section 128-20 of the ITAA 1997 at the time they became absolutely entitled and the property would therefore become part of their estate after their death. The property was acquired by the deceased after 20 September 1985 and it was their main residence until they moved into a nursing home. The property was not used to produce assessable income and therefore it may be treated as the deceased’s main residence until their death. The property was sold and settled within two years of the deceased’s death, and as such the main residence exemption is able to be applied to disregard the capital gain made on the disposal of the property by the deceased’s estate.