Capital Gains Tax in Deceased Estates: Common Executor Mistakes

Overview: CGT and Deceased Estates

CGT applies to capital gains made on the disposal of CGT assets — broadly, almost any kind of property, including real estate, shares, managed-fund units, business goodwill, intellectual property and collectables above certain thresholds. A capital gain or loss arises when a CGT event happens. The most common CGT event for an estate is event A1 — a disposal of an asset.

Death is not a CGT event in itself. Instead, Division 128 of the Income Tax Assessment Act 1997 (Cth) tells us what happens when an asset passes from the deceased to the executor and then to a beneficiary. Broadly, the gain or loss that would otherwise be triggered by death is disregarded, and the asset rolls through to the beneficiary at a cost base determined under Division 128. The point at which CGT is actually paid is generally when the executor sells the asset during administration, or when the beneficiary sells it after inheriting it.

Division 128 Rollover Relief

Division 128 is the central CGT rule for deceased estates. Its key features are:

• any capital gain or loss the deceased would otherwise make on death is disregarded;
• when an asset passes to the executor and later to a beneficiary, the same treatment continues — the asset rolls through;
• the executor (and later the beneficiary) inherits a cost base determined under Division 128;
• different rules apply to pre-CGT assets, post-CGT assets and the deceased's main residence;
• the rollover is limited to assets the deceased owned at the date of death and that pass under the will or under intestacy — it does NOT extend to assets the estate acquires after death.

Understanding which assets are inside Division 128 and which are not is the single most important CGT judgement the executor has to make. The error we see most often is applying the rollover to assets that should never have attracted it — particularly DRP shares allocated after death (discussed below).

Assets Acquired Before Death

For assets the deceased acquired BEFORE 20 September 1985 ('pre-CGT assets'), Division 128 resets the cost base in the hands of the executor (and the beneficiary) to the asset's market value at the date of death. A current valuation as at the date of death is essential — without one, the cost base cannot be defended on a later sale. Pre-CGT status is preserved only in the sense that the deceased's exposure is wiped; in the estate, the asset is treated as post-CGT with a date-of-death cost base.

For assets the deceased acquired ON OR AFTER 20 September 1985 ('post-CGT assets'), Division 128 generally rolls over the deceased's cost base and reduced cost base to the executor. The acquisition date for the 12-month holding test for the 50% CGT discount runs from the deceased's original acquisition date — so a beneficiary who inherits a long-held parcel of shares does not have to wait 12 months after the date of death to access the discount. The deceased's cost base history — purchase price, incidental costs, capital improvements, capital works deductions previously claimed — must all be reconstructed and retained.

Assets Acquired After Death

Division 128 does NOT apply to assets the estate acquires after the date of death. Such assets are treated as ordinary acquisitions by the trustee of the estate. Their cost base is what the estate paid for them; the acquisition date is the date the estate acquired them; and a sale by the executor crystallises a CGT event in the estate that is reported in the estate's trust tax return.

The most common categories of estate-acquired assets are:

• DRP shares allocated under a dividend reinvestment plan with an allocation date AFTER the date of death;
• bonus issues, rights issues and demutualisation shares with a record date after the date of death;
• shares or units the executor purchases with estate cash (for example, to invest surplus cash during a long administration);
• units in a managed fund acquired through a distribution reinvestment with a post-death issue date; and
• any asset the executor acquires in an arms-length transaction during administration.

Treating these assets as if they had rolled over from the deceased is one of the most common — and most costly — errors in estate CGT administration. It overstates the cost base, understates the gain on sale and, when corrected, exposes the executor to amended assessments and shortfall penalties.

Cost Base Issues

The cost base of an inherited CGT asset is the foundation of every CGT calculation the executor and the beneficiary will ever make on that asset. The executor's first job is to reconstruct it:

• obtain the deceased's original purchase contract, contract notes or settlement statements;
• obtain stamp duty assessments, legal fees and incidental acquisition costs;
• identify capital improvements, including dates and amounts;
• obtain capital works schedules where applicable;
• identify any non-deductible ownership costs (rates, interest, insurance) for assets acquired after 20 August 1991, which may be added to cost base if not previously deducted;
• identify any prior CGT events affecting the asset (e.g. a previous part-disposal or a roll-over).

Where the deceased's records are incomplete, the executor should engage an accountant early to reconstruct what can be reconstructed and to document the gaps. Reconstructing cost base ten years after death is materially harder than doing it in the first six months.

Main Residence Exemption Considerations

The deceased's main residence is one of the most commonly-mishandled CGT assets in an estate. The headline rule is that the executor can sell the dwelling within two years of the date of death without CGT, provided certain conditions are met. The detail is more nuanced.

• The dwelling must have been the deceased's main residence just before death and must NOT have been being used to produce assessable income at that time.
• If both conditions are satisfied, a sale settled within two years of death is fully exempt.
• The Commissioner has a discretion to extend the two-year period — for example, where the will is contested, where a TFM claim has delayed administration, where probate has been delayed by factors outside the executor's control or where settlement is delayed by genuine commercial issues. Extensions are not automatic and should be applied for in writing.
• Where the dwelling was being rented at the date of death, the special cost base rule resets the cost base to market value at the date of death and the gain on sale is calculated by reference to that value and the post-death ownership period.
• Where the dwelling was the deceased's main residence for only part of their ownership, a partial exemption is calculated on a day-count basis.
• Where a beneficiary inherits the dwelling and lives in it as their main residence, the exemption can continue to apply in the beneficiary's hands subject to further rules.

A date-of-death valuation should be commissioned promptly for any dwelling that may not qualify for full exemption, so the valuer can support the value with comparable sales from the relevant period.

Investment Properties

An inherited investment property is a post-CGT asset with a rolled-over cost base from the deceased. On sale by the executor, the gain is sale proceeds (less incidental costs of sale) minus the rolled-over cost base, reduced by the 50% CGT discount where the combined holding period (the deceased plus the estate) is at least 12 months. Capital works deductions previously claimed by the deceased reduce the cost base.

Where the executor transfers the property in specie to a beneficiary entitled to it under the will, the transfer is not a CGT event for the estate — the beneficiary simply inherits the cost base and will face CGT on a later sale. Modelling the difference between selling inside the estate and transferring in specie is one of the most important decisions the executor will make for any inherited investment property, and one of the most common situations in which accounting advice repays its cost many times over.

Shares and Managed Funds

Inherited shares and managed-fund units are post-CGT assets with a rolled-over cost base from the deceased (subject to the pre-CGT and DRP rules). The 50% CGT discount applies on sale by the executor where the combined holding period is at least 12 months. Capital losses realised by the estate during administration can be offset against gains in the same year or carried forward to later years of the estate (they cannot be transferred to beneficiaries when the estate is wound up).

For each parcel of shares, the executor needs to identify the original acquisition date and cost base in the deceased's hands, any prior part-disposals, any corporate-action adjustments (mergers, demergers, scrip for scrip rollovers) and — critically — any DRP shares allocated after the date of death. Share registries and broker statements usually contain enough to do this, but the analysis is fiddly and benefits from accounting support.

Dividend Reinvestment Plan Shares Acquired After Death

DRP shares deserve their own discussion because they are the single most common source of CGT error in estate returns. The rule is straightforward: if a DRP share has an allocation date AFTER the date of death, it is not covered by Division 128. It is an ordinary acquisition by the trustee of the estate (or by the beneficiary, once the holding has been transmitted into the beneficiary's name). Its cost base is the DRP reinvestment price; its acquisition date is the allocation date.

The practical consequences are:

• When the executor sells the entire holding, the parcel must be split for CGT purposes — the original (rolled-over) shares on one calculation, the post-death DRP shares on another.
• The 12-month holding test for the 50% CGT discount runs from the DRP allocation date for the post-death shares, not from the deceased's original acquisition.
• The cost base of the post-death DRP shares is the reinvestment price — usually meaningfully different from the rolled-over cost base of the deceased's original parcel.
• An estate return that treats post-death DRP shares as if they had rolled over from the deceased will materially overstate the cost base, understate the gain and, on amendment, attract failure-to-take-reasonable-care or no-reasonable-care penalties.

Where a DRP is active on a holding at the date of death, the executor should consider cancelling the DRP early in the administration so that no further post-death allocations occur. Reviewing the share registry's holdings statement at the date of death and immediately after is the simplest way to identify any post-death DRP allocations that will need to be tracked separately.

Estate Administration Period

The administration period runs from the date of death until the residue is fully ascertained — broadly, when assets have been collected, debts and taxes have been paid and the residue is calculable. During the administration period, the executor is the legal owner of the assets and is the relevant taxpayer for CGT events on the estate's assets. CGT events realised by the executor are reported in the estate's trust tax return for the relevant income year, and gains can be streamed to specifically entitled beneficiaries under the streaming rules.

For broader context on what an estate tax return covers, see our article on when an estate income tax return is required and on who pays tax on estate income in Australia.

Asset Sales by Executors

When the executor sells an inherited CGT asset, the gain is calculated under the ordinary CGT rules using the rolled-over cost base (or the date-of-death market value for pre-CGT assets and rented main residences). The timing of the sale matters — selling on 30 June versus 1 July moves the gain into a different income year, with potentially different beneficiary entitlement, different CGT discount outcomes and different exposure to section 99A treatment if the gain is accumulated.

Executors should be slow to sell major CGT assets without first modelling the tax outcome with the estate accountant. In many estates, the order in which assets are sold — and whether they are sold at all, or transferred in specie — is the single largest tax decision the executor will make.

Asset Transfers to Beneficiaries

An in specie transfer of a CGT asset from the executor to a beneficiary entitled to receive it under the will is generally not a CGT event for the estate. The beneficiary inherits the executor's cost base — which, for assets the deceased owned at death, has rolled through from the deceased. The beneficiary's acquisition date for the 12-month CGT discount holding test runs from the deceased's original acquisition date for rolled-over assets, and from the DRP allocation date for any post-death DRP shares that are transferred in specie.

The executor should provide the receiving beneficiary with a complete cost base record at the time of transfer — including the deceased's purchase records, any capital improvements, any prior part-disposals, the apportionments for any partial main residence exemption and the separate treatment of any post-death DRP shares. That handover is one of the most valuable things a careful executor does for a beneficiary, and one of the most often-neglected.

Testamentary Trusts and CGT Issues

A testamentary trust established under the will is a separate trust for tax purposes and lodges its own trust tax return. CGT events occur in the testamentary trust when its trustee disposes of trust assets. The 50% CGT discount can apply, and capital gains can be streamed to beneficiaries specifically entitled to them.

The flexibility of a testamentary trust — and the income tax concession for income paid to minor beneficiaries from a testamentary trust — is part of why it is a common vehicle for holding CGT-heavy inherited assets. But it adds complexity and ongoing administration, and the streaming rules must be followed precisely each year. See our article on testamentary trusts explained for the broader framework.

Capital Gains in Estate Tax Returns

Capital gains realised by the estate are included in the estate's net income for the year, after current-year and carried-forward estate capital losses are applied and after the 50% CGT discount where available. Where a beneficiary is specifically entitled to the gain, the gain is streamed to that beneficiary in the distribution statement and the beneficiary includes it in their own return. Where no beneficiary is specifically entitled, the trustee is assessed — and may be exposed to section 99A treatment if the gain is accumulated outside the early administration period.

Streaming the right CGT amount to the right beneficiary in the right year is the single most important estate-tax-return technique for managing CGT in a deceased estate. It requires the executor, the accountant and (often) the estate lawyer to coordinate from the start.

Record Keeping Requirements

CGT records should be kept for the life of the asset plus five years after disposal. For a deceased estate that holds an asset for a year and then transfers it in specie to a beneficiary, the relevant CGT records run with the asset into the beneficiary's hands and beyond. Records that should be obtained and retained include:

• the deceased's original purchase contracts, contract notes and settlement statements;
• stamp duty assessments, legal fees and incidental acquisition costs;
• capital improvement invoices and dates;
• capital works schedules and the deceased's prior depreciation and capital works claims;
• share registry holding statements at the date of death and immediately after;
• DRP statements, including allocation dates and reinvestment prices;
• date-of-death valuations for pre-CGT assets and for any dwelling that does not qualify for full main residence exemption;
• distribution statements for any in specie transfers; and
• the estate's trust tax returns and ATO assessments for every administration year.

Common Executor Mistakes

The mistakes we see most often in estate CGT administration are:

• failing to reconstruct and retain the deceased's cost base records for inherited assets;
• applying Division 128 rollover to DRP shares allocated after the date of death;
• selling the deceased's home outside the two-year main residence window without obtaining an extension;
• failing to commission a date-of-death valuation for a rented dwelling or a pre-CGT asset;
• selling a major CGT asset without modelling the tax outcome with the accountant;
• missing the 50% CGT discount on assets where the combined holding period was at least 12 months;
• failing to stream a capital gain to a specifically entitled beneficiary, exposing the estate to section 99A treatment;
• distributing the residue before lodging the estate return that reports the gain, leaving the executor personally exposed;
• treating the deceased's unused capital losses as if they could be carried into the estate; and
• not providing the beneficiary with a full cost base record on in specie transfer.

Common Beneficiary Misunderstandings

Beneficiaries commonly misunderstand CGT in deceased estates in three ways. First, that inheriting an asset 'resets' the cost base to market value at the date of death — true only for pre-CGT assets and (broadly) rented main residences; not true for ordinary post-CGT assets. Second, that inheriting the deceased's home is automatically CGT-free — true only if the two-year rule and the main residence conditions are met. Third, that no CGT applies until the beneficiary sells — broadly true for in specie transfers, but the beneficiary inherits the executor's cost base (not market value at the date of receipt) and the CGT on sale is calculated from that cost base. Beneficiaries should request a full cost base record from the executor as part of the distribution and should keep it for the life of the asset plus five years. See also our article on beneficiary rights during estate administration.

When Accounting and Legal Advice Should Be Obtained

Accounting advice on CGT should be obtained at the very start of administration — before any asset is sold, before any in specie transfer is documented and before the deceased's home is listed for sale. A tax-qualified accountant can model the CGT outcomes of selling versus transferring each asset, identify which income year a disposal should occur in, calculate the impact of the CGT discount and the streaming rules, and integrate the CGT analysis with the estate's overall tax position.

Specialist estates legal advice should be obtained wherever CGT interacts with a legal question — for example, where the will creates a testamentary trust holding CGT assets, where the residue is being calculated and a CGT liability has to be apportioned between beneficiaries, where the deceased's main residence is the subject of a TFM claim, where the executor proposes to transfer an asset in specie rather than sell, or where a beneficiary disputes how a gain has been streamed. Coordination between lawyer and accountant from the outset is the simplest way to keep the estate's CGT exposure under control. Our companion articles on executor duties in Victoria, probate in Victoria, what happens to a company when a director or shareholder dies and the death of a business owner in Victoria cover the surrounding administration framework and the additional steps required where the estate holds business assets.

How Parke Lawyers Can Help

We act for executors, beneficiaries, accountants and families across Australia on the legal aspects of estate administration that intersect with CGT — modelling the sale-versus-transfer decision, documenting in specie distributions with full cost base records, establishing and administering testamentary trusts, advising on the interaction between CGT and the main residence exemption, and resolving disputes about how capital gains have been streamed. Our services in this area include probate and estate administration, wills and estate planning and commercial and business law.

This article is general information only. It is not taxation advice and it is not legal advice. Capital gains tax in deceased estates is technical and depends on the facts of the individual estate. Executors and beneficiaries should obtain advice from a tax-qualified accountant and a specialist estates lawyer before selling an estate asset, transferring an asset in specie, or distributing estate income that includes a capital gain.

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