You settle on the couch with a glass of wine after a long and exhausting day. Your husband has been flat out harvesting and you didn’t realise just how useful he actually is around the house and with the kids. You’re buggered and behind on your work as you had to leave early to pick up the kids after your babysitter bailed on you. So, despite your exhaustion, you log in to try and catch up.
With The Crown playing in the background, you start to wade through your emails.
You see there is an email marked urgent from one of your longstanding clients, Charlie that had arrived not long after you left that afternoon. You had prepared his mother, Lizzie’s will and subsequently acted for her estate.
Lizzie died leaving 4 children, Charlie, Annie, Andy and Eddy. Lizzie had wanted to treat her children as equally as possible while at the same time taking into account Annie’s desire to end up with the family beach house in Mollymook.
Annie had her share of troubles over the years and the beach house had become a sanctuary for her, particularly after her separation with her husband. When making her will, Lizzie told you that Annie had always told her that one day she would like to live at the beach house, as it was a place that helped her get through some very tough times.
So you prepared Lizzie’s will with Annie being given the option to buy the beach house at market value. At the time you advised Lizzie this would be the best way to deal with the beach house as it would mean Charlie, Andy and Eddy would not be able to sell to anyone else against Annie’s wishes. If Annie wanted the beach house she could buy at market value, thus achieving equality. On the other hand, if Annie decided she didn’t want to buy, it could just be sold on the open market and again equality would be achieved.
After Lizzie died, Annie decided that she did want the beach house so she exercised her option. You arranged for the house to be valued and then finalised the estate by transferring the beach house to Annie with the required cash adjustments in favour of Charlie, Andy and Eddy.
The sting
As you read through Charlie’s email your heart sinks. Lizzie’s estate was picked for a random audit by the ATO and a tax assessment has issued to the executors for capital gains tax on the transfer of the beach house to Annie.
When you arranged for the estate to be distributed you had advised the family that the CGT exemption on death applied.
“This must be wrong” you hopefully think to yourself. You frantically start to google “options in wills and CGT” and come across the very distressing realisation that the ATO audit is correct.
The issue is that the CGT exemption on death only applies to assets that pass under a will.
Under section 128-20 (2) of the Income Tax Assessment Act 1997 a CGT asset does not pass to a beneficiary if the beneficiary becomes the owner of the asset because your *legal personal representative transfers it under a power of sale.
Further, page 645 of the Australian Master Tax Guide for 2021 says:
However, an asset does not pass to a beneficiary of the deceased taxpayers estate in circumstances where the beneficiary becomes the owner of the asset because the deceased taxpayers legal personal representatives transfers it under a power of sale. This is so even if such a sale happen because the beneficiary exercises an option granted by the deceased’s will.
The beach house was acquired just after CGT commenced in September 1985 for $180,000. The market value when it was transferred to Annie was $3.3m, so the capital gain is around $2.8m.
You get up, pour yourself a whiskey then continue read through the legislation for a solution. On your 2nd glass you realise that, whilst the horse has already bolted, there could have been another way to ensure Annie ended up with the beach house…..