Tax Tip 220: Strategy to Avoid CGT for generations to come (forever?)

When someone dies their assets pass via their will, or intestacy laws, without triggering CGT. The beneficiary’s cost base of the asset is generally the same as the cost base of the person who left it to them.

Example

Homer dies and leaves some shares to Bart. Neither Bart nor the estate pay CGT on the shares passing through to Bart. If Bart sells, he would pay CGT on the shares and his cost base would be the same as Homer’s cost base. So if Homer bought them for $100,000 and they were worth $500,000 on Homer’s death and Bart held them for 10 years and then sold them for $1mil, Bart’s cost base would be $100,000 and he would have made a capital gain of $900,000 (the tax would be about $210,000).


But if the shares are not sold but hung onto and the passed on via the beneficiary’s will, there will still be no CGT payable until they are sold.


Example cont.

Bart inherits Homer’s shares and then Bart dies. Bart some Bartyboy inherits the shares. If Bartyboy sells the shares his cost base will be $100,000.


So, the way to avoid CGT is for each generation of the family to keep the shares without selling. Selling the assets inherited is like killing the goose that lays the golden eggs.


Shares could be sold and later the proceeds reinvested, but each time they are sold up to 25% of the value is lost in CGT. Therefore, not selling for hundreds of years could allow for some massive compounding.


But what about the inflexibility of income distribution? One drawback of inheriting shares is that there is little opportunity to divert income to a spouse, and/or children unless they are held in a discretionary trust. Holding assets in a discretionary trust means those assets cannot pass via a person’s will. Trusts generally must vest every 80 years so that means CGT would be triggered every 80 years time, wiping out about 25% of the value of the assets.


However, there is a way around this too.


In this thread,

Tax Tip 194: Transferring a Property from a Testamentary Trust to a Beneficiary Without CGT Tax Tip 194: Transferring a Property from a Testamentary Trust to a Beneficiary Without CGT

I showed how it is possible to transfer assets out of a testamentary discretionary trust (TDT) to a beneficiary without triggering CGT.


Therefore, the solution to avoid paying tax is to set up a TDT in the will. Upon the death of the testator the assets will pass to one of more trustees of a TDT. Income from the shares can be streamed to the primary beneficiary and their spouses and children with real tax advantages (as well as asset protection).

When that primary beneficiary is about to die, or possibly even after their death, the assets of the trust, such as shares are transferred into their estate and then out into a new TDT. Their children will control this trust and can stream the income out and then upon their death, the same thing can happen.

The result is hundreds of years of compounding of the capital based with very little tax paid on the dividends in between – in theory, and assuming current laws allowing this will not change.


Example

Homer is fit and healthy and writes his will incorporating a TDT for each child. Homer buys some shares and keeps compounding the returns so that at his death he has a large amount paying good dividends. His will leaves 1/3 to each of 3 TDTs each controlled by one of his children.

Bart controls one TDT and keeps the shares in it with the income being streamed to his children and spouse largely tax free. Bart keeps investing in shares outside the TDT (as injecting money into it won’t result in tax savings).

Bart comes down with a diagnosis of cancer and has 4 weeks to live. Dr Hibbert tells him the bad news and says sorry it has taken you 3 weeks to get an appointment to see me, you only have 1 week left.

Bart causes the assets to be distributed from the TDT to himself, without triggering CGT.

Bart dies a few days later.

Bart’s estate is now much larger than when Homer died.

Bart’s will also has a TDT and he goes for the same strategy.

Bartboy junior continues the tradition and does the same thing as his dad, Bart.

Bartyboy junior dies at a rave party, without children. But luckily his wills sets up a TDT with his siblings taking over the tradition.



This strategy can work well with shares as there is no stamp duty on the transfer of shares, but with property passing from a trustee to a individual is it likely to trigger duty in many states – perhaps exemptions might apply in VIC and WA in certain situations.



The best thing though is if one generation decides they want to sell up and abandon the tradition, then there will still be tax savings by utilising a Testamentary Discretionary Trust.

 

Quote..
But if the shares are not sold but hung onto and the passed on via the beneficiary’s will, there will still be no CGT payable until they are sold.

Sort of gives one peace of mind when I read this as I have known about this for a while and all within myfamily who's names are on the hin numbers,and no-one ends up barefoot and broke with 20 cents in the back pocket..

 

Thanks for all your great tips, Terry.

So if you are the trustee of a discretionary trust that is close to vesting are there any strategies for selling/transferring assets that would minimise CGT? Or just have to take the ~25% hit and be glad that at least 75% might then go into a personal estate which could then become part of a TDT?

Because of this I suppose there's a certain point at which, assuming there are no asset protection considerations, transferring more assets into a family trust can be counterproductive for long-term family wealth building?

 

Yes there are.