Q&A – Cost base of inherited property

A: Cost base

The cost base of a property for the purpose of capital gains tax (CGT) may consist of five elements:

1. The first element is any money paid or property given for the asset. Where no consideration is paid the market value substitution rule generally applies – the market value of the asset is the first element of the cost base. 
2. The second element includes incidental costs of acquiring the asset or that relate to the CGT event. Examples are fees for services of a valuer, auctioneer, accountant, agent, legal adviser, costs of transfer, stamp duty, advertising to find a buyer, loan application and mortgage discharge fees. 
3. The third element includes the costs of owning the CGT asset. Examples are rates, land taxes, repairs, insurance premiums and any non-deductible interest on borrowed money used to purchase the asset and capital expenses to increase the asset’s value. These expenses can be included in the cost base only if they are not deductible. 
4. The fourth element includes capital costs to increase or preserve the value of your asset or to install or move it such as installation costs and zoning change application fees.
5. The fifth element includes the capital costs of preserving or defending the owner’s title or rights to the CGT asset.

Cost base of a CGT asset that is inherited

The property was previously a pre-CGT asset as it was acquired prior to 20 September 1985. As the property was jointly owned, each joint owner holds their equal interest in the asset as separate pre-CGT assets, according to the Income Tax Assessment Act 1997 - SECT 108.7.

The capital gain from a pre-CGT asset is exempt from tax. The capital gain of a CGT asset is assessable income to its owner; however the capital gain may be reduced if the asset has been owned for at least 12 months by applying either:

• The indexation method (only for an asset acquired before 21 September 1999) which increases each amount included in an element of the cost base (except those in the third element) by an indexation factor calculated as:
  CPI for the quarter ending September 1999 (68.7)
  CPI for the quarter in which expenditure was incurred (eg 57.1 for second quarter of 1990)
• The 50% CGT discount, which reduces the gross capital gain by half.

Where the CGT asset was acquired as a legal personal representative or a beneficiary of a deceased estate, the 12-month requirement is met where the deceased acquired the asset 12 months or more before it was disposed.

Cost base of the father’s former 50% interest in the property

When your client’s father passed away in May 1990 his interest in the property passed on to the surviving joint tenant, your client’s mother. As she acquired his interest at the time of his death after 19 September 1985 it becomes a CGT asset. The first element of its cost base is $26,000 (50% of $52,000, the market value of the property at the date of death) plus any transfer costs (second element). 

From that time, a proportional share of expenses relating to the property such as rates, land taxes, repair, insurance premiums or any non-deductible interest for borrowings used to acquire the property (third element) are added to its cost base. When your client’s mother died, the beneficiaries assumed her cost base for this interest. A proportional share of the selling costs of the property is also included in the cost base.

For the purposes of the 12 month period required to be eligible for either the indexation of the cost base or the 50% CGT discount this interest is deemed to have been acquired by the beneficiaries when the mother acquired it (May 1990). 

Cost base of the mother’s former interest

The mother’s original interest in the property was a pre-CGT asset until her death (January 2017). At that time it became a CGT asset with the first element of the cost base being $100,000 (50% of $200,000, the property’s market value at that time). Similarly, a proportional share of expenses related to the interest falling under any of the five elements of the cost base started to be added to its cost base. 

For the purposes of the 12 month period required to apply the CGT discount the interest was deemed to have been acquired by the beneficiaries when the mother passed away (January 2017)

50% CGT discount or indexation of the cost base

Each interest in the property will have a different cost base. The capital gain for each interest is equal to its capital proceeds less its cost base. 

The 50% CGT discount can be applied to both interests in the property. Your client’s mother had held the father’s interest for longer than 12 months and the beneficiaries held the mother’s interest for more than 12 months before the sale. 

Indexation may be applied to increase the cost base of the father’s former interest as it is deemed to have been acquired in May 1990 (before 21 September 1999). The beneficiaries may choose to either index the cost base of this interest or to reduce its assessable capital gain with the 50% CGT discount – but not both. 

Tech tip: Records should be kept to calculate capital gains on the sale of an asset:

• When the deceased acquired the asset
• If the deceased acquired the asset prior to 20 September 1985 (pre-CGT asset), the asset’s value on the date the deceased died
• If the deceased acquired the asset after 19 September 1985 (CGT asset), receipts of purchase or transfer, interest on borrowed money, cost of agents, accountants, legal, advertising, insurance costs, land rates, taxes)
• Costs relating to the asset which were incurred by the legal personal representative of the deceased estate or the beneficiary (market valuations)
• Clients should obtain tax advice from a qualified tax agent when dealing with complex CGT matters.