While selling the family home is in nearly every situation tax-free, the tax treatment of selling their home can often become more complicated when someone dies.

Capital gains tax (CGT) can still be eliminated or significantly reduced, but some planning may be needed both when the owner draws up their will and in the way that their Estate is administered.

The most important rule is that the sale of the home is tax-free when sold within two years by either the Estate or the beneficiaries if it was the deceased’s main residence just before their death. The ATO has the ability to extend the exemption period and will often do so when there are clear reasons for the delay that were outside the control of the taxpayers, most commonly where the Will has been the subject of a legal dispute preventing the sale.

Even where the two-year limit is breached, the sale will be tax-free where the home is at all times following the date of death the main residence of:

  • the deceased’s spouse;
  • another individual who has a right to occupy the home under the Will; or
  • the beneficiary who inherited the home under the Will.

With the second category this may apply where, for example, a house is inherited equally by a daughter and two sons from their mother and one of the sons is allowed to remain living in the house for five years before it is sold. If this is the family’s intention, provision for this situation must be explicitly included in the terms of the mother’s Will.

If by contrast this was simply an informal agreement between the three siblings, while the one-third interest of the son living in the house will be tax-free, the share of their brother and sister will be subject to CGT. Broadly, the capital gain would be calculated based on the increase in market value from their mother’s death to the date the house is actually sold.

Another increasingly common variation is when the deceased has moved into aged care and their home is sold some years later after their death. In those cases, the “absence rule” can be applied to treat the home as their main residence even after they physically move out. The exemption period is limited to six years if the home is rented out, but there is no limit if no rent is received.

If the absence rule can be applied for the whole period, the home will retain the full benefit of the CGT main residence exemption and the normal rules as discussed above will apply. If, however, rent has been received and the six-year absence period is exceeded, there is a pro-rata exemption available based on the percentage of “main residence days” over the total days held.

For example, Phoebe owned her house for exactly 19 years, and it was sold exactly one year after her death. For the last nine years before she passed away Phoebe lived in a nursing home and received rent from her house. She can treat six of the nine years as exempt, but three of them will be treated as “non-main residence days”, as would the entire period from her date of death until sale.

This means that the house will be tax-free for 16 out of the total ownership period of 20 years, but 20% of the total capital gain (i.e., 4 out of 20 years) will be taxed to the Estate.

In summary, while selling the family home is usually tax-free, the devil is in the detail when inherited from a deceased estate and careful planning can make a big difference to the overall tax outcome.

This article was first published in Personal Wealth Adviser Issue 5.