Is there an inheritance tax in Australia? How much do you pay when you inherit assets from a loved one?
In this article, we will guide you through the potential taxes you can face when inheriting assets in Australia, implications, and more. We'll also break down its significance to you and your family. From planning your estate to making sense of the legal stuff, we've got the answers you need. So let's dive in.
Understanding the Concept of 'Inheritance Tax'
The topic of inheritance tax is often a blur to Australians because there is no defined inheritance tax. Indeed, many inheritances attract no tax and the notion of taxing an entire estate was abolished in Australia in 1979. Still, that doesn't mean you won't pay applicable taxes on assets if a loved one passes. This matters greatly in estate planning, and should be everyone's priority— both estate givers and inheritors.
The critical consideration is whether any tax would have been payable if the previous owner were to have sold the asset before they passed (noting that there are some exceptions for assets held inside superannuation).
If you inherit assets or planning to pass them on, those assets may therefore come embedded with unpaid tax liabilities. So in this sense you can inherit an asset with tax attached, although you're not immediately required to pay taxes settle this unpaid tax when you inherit the asset.
The Composition Of Estate Taxes
To understand estate taxes which may apply, it's best to understand the differences between the taxes derived from income, and taxes derived from a capital gain. Income-related tax is typically the tax payable for the given financial year that the income is distributed. For this reason, any income-related estate tax should only be addressing the income which was earned immediately before the asset was inherited.
Capital gain-related tax operates differently because it's not paid each year, instead building up as the value of your investment grows. When you 'dispose' of the asset - meaning the ownership changes for instance via sale or gift - the tax is then payable. For this reason, capital gains tax amounts can often be very high, as they have accrued for many years.
It's also important to note that both taxes may apply simultaneously. Consider a property investment: you will have ongoing income (rent) which may attract income tax each year, and growth on the value of the property (capital gains) which the tax assessment is not payable until you sell the property.
Importantly, an asset being inherited does constitute a 'disposal' - because the beneficial owner will change. Imagine you were to inherit your late uncle's investment property which was bought at $200,000 and is now worth $400,000. No tax has been paid on that property because the tax relates to a capital gain, which is only triggered upon disposal. This said, there has been an investment gain from $200,000 to $400,000 and that tax does need to get paid eventually.
When Am I Required to Pay the Tax on an Inherited Asset that Made a Profit?
Using the investment property example above, the Australian Taxation Office (ATO) is firm on the fact that tax must be paid. They have however recognised that demanding people pay this tax as soon as an asset is inherited may create problems - namely that the beneficiary doesn't have the free cash to meet this tax obligation. This under taxation law would ultimately require many assets to be sold immediately upon inheritance, so the beneficiary can meet the imminently payable tax liability.
To address this, the ATO has decided to defer the capital gains tax event until the asset is sold by the beneficiary, at which point they should have the free cash to meet the tax liability. Using the above scenario (you inherit your late uncle's $400,000 investment property with a purchase price of $200,000), you elect to keep it as an investment property for another decade, eventually selling it for $800,000. Good investing, but remember that two amounts of capital tax are owing upon sale:
- Firstly, the capital gain whilst the asset was in your name ($800,000 disposal value less $400,000 acquired value = $400,000 capital gain)
- Secondly, the capital gain whilst the asset was in your late uncle's name ($400,000 disposal value less $200,000 acquired value = $200,000 capital gain)
So in this case you're on the hook for a $600,000 capital gain. After the 50% CGT discount, you'll likely have the remaining $300,000 added to your assessable income for that year and pay tax ranging from $110,000 to $141,000, depending on your income for that given year.
Legal Framework Governing Inheritance in Australia
Australia's inheritance laws are complicated because they combine federal and state regulations. Since every state has different laws concerning estate planning, people must be familiar with the laws in their state. Seeking professional advice in this area will increase the likelihood that all legal requirements are met when assets are inherited.
Inheritance Tax Implications for Australian Residents
The impact of inheritance tax on Australians depends on their residency. Although Australia doesn't impose an inheritance tax, Australian residents may face tax obligations on inherited assets from abroad. For example, if an Australian inherits property from a country with an inheritance tax, they must pay tax under those laws.
The Australian Tax Office (ATO) may tax any earnings generated from these inherited assets, such as rental income derived from overseas property. Australians, especially those with ties to countries that impose inheritance taxes, should know the details of tax residency and how it affects inheritance.
International Aspects of Inheritance Tax for Australians
The tax laws of different countries are extremely intricate and require specialist advice. Australians inheriting assets from abroad must consider tax obligations in the asset's source country and how Australian tax law treats them. For example, some countries have arrangements with Australia that lessen the burden by eliminating double taxes.
Managing foreign assets can be very significant because when talking about inheritance tax, we are talking about Australian tax law. Other countries, of course, do have inheritance taxes, and therefore, their tax laws might apply depending on the jurisdiction of the asset, where the deceased person resided before they passed, and what tax jurisdiction they were in.
For example, Australia has a double taxation agreement established with the United States to basically ensure that if a person's already been taxed in the United States, they are unlikely to also be taxed in Australia.
Strategies to Minimise Tax Liability
Excess tax can be a great liability to you, but— not to worry— you can minimise their financial effects. In estate and tax planning, these are some of the strategies that can help you minimise your tax liability.
1) Trust Creation
Many wills are very basic and may stipulate that a certain asset goes to the deceased person's estate A, but do not stipulate how person A can acquire that asset. However, better quality wills include provisions for ownership such as a testamentary trust.
In that case, person A would be able to accept that asset freely, but they would also be able to inherit that asset instead into their name via a trust. The benefits of this ownership can be significant, with both enhanced tax and asset protection benefits.
2) International Tax Awareness
Tax regulations in asset-locating countries need to be studied. To guarantee compliance with applicable taxes and a successful transfer of wealth to beneficiaries, we recommend engaging with a specialist estate planner. This may help people navigate tax requirements, avoid liabilities across international borders and more broadly maximise estate planning outcomes.
3) Seek Professional Advice
Seeking advice from experienced tax professionals helps you know how much tax is expected, especially regarding overseas income stream inheritance. Our experts help people navigate complicated laws and make informed choices that align with their financial goals.
Professional consultants also provide customised techniques to meet specific tax difficulties. Financial advisors are in a unique position in Australia in that they understand both the direct tax' side and the estate planning side. If you need this kind of advice, we're more than happy to provide you the guidance you need! Get in touch with us today.
4) Life Insurance Consideration
The proceeds from life insurance can be used strategically to reduce taxes owed. Proper policy structuring allows people to support dependents financially while potentially lessening the burden of any tax obligations. This can ultimately lead to tax return and a more seamless wealth transfer process.
Secure Your Financial Future with Our Budget Planner
Start building a better financial future with our free budget planner template.
Download Budget Planner
Common Misconceptions About Inheritance Tax in Australia
One of the major misconceptions is the fear of inheritance tax (as opposed to inherited capital gains tax), and the amounts that are likely to be payable.
We often meet people who are genuinely fearful that if they inherit assets, they will have a huge amount tax stripped away from it, for instance 50% or even 30%. In our experience this is very rare. Our members are often quite surprised with fairly reasonable tax outcomes associated with inheritance - and this tax can be lessened with a number of personal income tax strategies for that relevant financial year.
Similar misconceptions happen regarding taxes payable due to overseas inheritances. Contrary to common knowledge, recipients of overseas inheritances are not always required to pay Australian income tax.
Inheritances are not directly taxed in Australia, regardless of where they come from. It's essential to be aware of possible tax implications, such tax rates such as capital gains tax, which can be applicable based on how the inherited asset is disposed of. Understanding these details is key for thorough financial planning and removing needless tax obligations.
Frequently Asked Questions (FAQs)
What is Inheritance Tax in Australia, and does it still apply today?
All states in Australia abolished inheritance taxes, which imposed taxes on money or property inherited from deceased estates by 1979. As a result, inheritance tax is no longer applied anywhere in Australia, removing the financial burden of inheritance tax on those who inherit assets from deceased estate.
Are Australians subject to inheritance taxes?
Capital gains tax may apply to assets inherited in Australia, especially when inherited property is sold or brings in money; but the country does not currently have a distinct inheritance tax. To effectively handle their estate administration and any tax requirements, people should make plans by their knowledge of expected tax obligations related to inherited assets.
What information regarding handling inheritances should Australians have?
Australians who get an inheritance should consider the possible tax implications, particularly capital gains tax. By seeking financial advice during this process, you can guarantee that inherited assets are managed smoothly, allowing you to negotiate tax concerns and make accurate tax financial decisions effectively.
Has the subject of restoring inheritance tax in Australia come up recently?
Though Australia has no current intentions or laws to bring back inheritance tax, the subject of tax returns is occasionally brought up for re-examination. It's oftens said that there are two certainties in life: Death and Taxes. We are sure of the taxes today, but can't be sure of them tomorrow!
Does an Australian resident have to pay Capital Gains Tax (CGT)?
When Australian residents dispose of assets and make a lump sum of profit (also know as a 'capital gain'), they could be required to make tax returns and pay capital gains tax. Real estate, stocks, and other investments are subject to this tax, but certain exemptions exist, such as the Principal Place of Residence (PPR) exemption which ensures that no CGT will apply upon sale, regardless of the profit you have made.
Can a super death benefit be taxed in Australia?
Yes! And we're sorry to say that this tax can be considerable - upwards of 20% of the amount being bequeathed. Effective financial planning can mitigate high taxes for your super beneficiaries, especially concerning sizable superannuation balances intended for adult children.
The tax on a super death benefit depends on:
- Whether you were a dependent of the deceased under tax law
- You paid tax as a lump sum or income stream
- Whether the super is tax-free or taxable
- Whether the super fund has already paid tax on the taxable component
- Your age
- The age of the deceased person when they died (for income streams).
Various strategies, implemented promptly and over time, can reduce tax burdens, aiming for minimal or zero tax liabilities when the next generation inherits assets. The topic of tax on superannuation death benefits is too large to adequately cover in this blog, so we will write another blog to address this shortly.
Conclusion
Although Inheritance Tax in Australia is no longer in effect, its influence is still seen in discussions about money. Inheritance concerns are still relevant to Australians today because of associated taxation and foreign factors. Consider how prepared you are to manage inheritance matters and look at ways to improve your understanding of future financial assets.
This includes considerations such as superannuation death benefit and the importance of careful estate planning. You can protect your financial future and anticipate further inheritance or estate tax-related financial complications or difficulties by staying informed and seeking professional advice.
James O’Reilly is the Director of Northeast, a fast-growing financial advice firm that empowers clients to achieve meaningful financial progress and well-being. He's also the co-host of the Australian Retirement Podcast, one of Australia's fastest-growing podcasts.