Tax Tip 344: CGT Exemption for Property Held in a Testamentary Trust

Normally a property held by the trustee of a discretionary trust will not qualify for the main residence CGT exemption. See
Tax Tip 52: Trusts and the main residence exemption for CGT Tax Tip 52: Trusts and the main residence exemption for CGT

However, there are special rules for properties held by the trustee of a deceased estate, including Testamentary Discretionary Trusts.

The relevant legislation is section 118-195 ITAA97

Basically, the rule states this:

If a residence of the deceased person passes to a trustee and it is the main residence of the spouse of the deceased

Or

If a residence of the deceased person passes to a trustee and it is the main residence of the a person who has a right to reside in the residence

Then, the main residence CGT exemption can apply to the property, even though it is held in a testamentary discretionary trust.

section 118-195 ITAA97

INCOME TAX ASSESSMENT ACT 1997 - SECT 118.195 Dwelling acquired from a deceased estate

 

Would the person with the right to reside have to be specified in the will?

Wouldnt that person also have cgt exemption if the property passed to them?

so it seems to be an option if the deceased does not want the property to pass to the spouse or beneficiary but want them to retain occupation rights.

 

Yes and Yes

But this is a way to gain flexibility and asset protection as well as control to a certain extent.

 

That is the very reason why the law exists. It allows a beneficial right to occupy without the need to have a legal "interest" which is what the main residence exemption requires...for an individual. A disc trust is too limited in that interest even if it were eligible. A testamentary trust owning a residence may work very effectively for minors etc and provide enhanced asset protection over gamblers, spendthrifts and persons at risk to creditors by leaving the property control to the trustee and the use to the beneficiary. If required the trustee may act as a custodian to protect the benefical interest from misuse eg Ex wife can reside but not sell and interest passes to kids.

I question if the absence rule can be used and have never seen a decision. The absence rule is not governed by s118-195 as such. s118-195 appears to be more precise in the terms of exemption.

The other fail for trusts and the exemption is explained well here. I have seen many (poor) websites that suggest disc and other trusts can access the exemption. Even a well known trademarked deed provider at one time suggested this
Tax Tip 52: Trusts and the main residence exemption for CGT

Its also very wise not to add further assets to the trust beyond the assets of the deceased. It can expose the property and defeat asset protection. Tax law in recent years has been changed to discourage that in any event.

 

Income on assets that were not part of the deceased estate would not have 102AG nature, right? So there is no benefit to adding to a tt as opposed to just creating a new family trust.

 

Assets that derive from the deceased estate. The don't have to have been owned by the deceased though.

 

Correct. I would argue a seperate trust is wise. Depends on the legal advice.

2018-19 Budget measure of “improving the taxation of testamentary trusts”, and the new law tax took effect from 1 July 2019

 

this is unclear to me and I cant figure it out from reading the legislation.

say the deceased owns 100 cba shares. The estate is run for 3 years, during which the drp results in 110 cba shares.

110 shares goes to the testamentary trust.

does dividends on all 110 cba shares have s102ag nature?

if dividends are further reinvested in the tt, do dividends on such shares (or shares acquired using cash dividends received by the tt) also have s102ag nature?

 

What happens to the income of the trust?

 

if reinvested in the tt (not distributed in cash), resulting in a upe to a minor beneficiary?

 

Then it might be mixed and not all taxed as excepted trust income

 

Thinking of it another way, it would then make sense to operate the estate for 3 years to maximise the tt assets on which the income complies with s102ag? Instead of transferring assets sooner from the estate to the tt. Noting that the estate is taxed as an adult individual.

 

The income of the trust estate can be used to acquire new assets where it is accumulated. The concern is an INJECTION. eg Wife wins $2m on powerball.
Taxation treatment of distributions of income from testamentary trusts to minors

The DRP is subject to Div 6AA.

 

The legislation actually says derived 'from the will' of the deceased.

 

So, in that reading, if the estate passes cash to the TT, and the trustee of the TT uses this cash to buy shares, are the dividends excepted trust income?

However, if these gains are not cash distributed to beneficiaries but reinvested, there seems to be two different opinions whether these reinvested assets using excepted trust income are considered as derived from the will of the deceased, or are an injection.

What would be the way to maximise except trust income (and assets) within the TT, without creating a mix of assets and income types (s102AG and non s102AG).

 

There is no need to consider the income and what is and isnt distributed. If the income is received by the trust thats sufficient to be accumulation - even if costs see it spent. If it accumulates then its part of the trust and excepted income can apply to it. To maximise the trustee may seek to be taxed on elements of income rather than a beneficiary (eg capital gains).

Rule of thumb ifs dont inject $$ to the TT without tax advice. eg no fifts, no associate loans to trust etc Then basically two major strategies
1. retain the TT for intergenerational wealth transfer
2. Reduce the TT in whole or part when adults attain age for super benefits to be considered in some cases

I have also seen TTs that specifically exclude family eg Adult kids (40s) so the TT benefits grandkids (their children) onwards. Just assisted winding up of one. Pre CGT 1970s property asset was sold. Trustee gifted $XXXK (distribution of trust capital) to each grandkid and vested trivial balance of cash . Parents got $0. Trustees of that trust also wanted to avoid testamentary issues for a "old trust" which had some clauses that were drafted long long ago based on modern legal advice. Each child gets a insurance bond now payable when they turn 25. Zero income tax and CGT applies as expected policy duration is 11-17 years.

 

So accumulation of trust income can occur, but that means there will be UPE against the minor beneficiary. ie income is distributed to minor as excepted income but cash is retained in the tt. All income remains excepted trust income.

assume no other injections other than the original assets from the estate.

 

Taking a simple example.

grandpa dies leaving just cash in the estate.

TT receives the cash and buys shares with it.

dividends etc retained in the trust.

All trust assets at any point in time are either
1) directly from the estate,
2) purchased with cash received from the estate,
3) are earnings from assets received from the estate or assets purchased with cash received from the estate,
4) are reinvested /purchased using (3).

Then all income is still excepted trust income.

As long as no assets from another source is injected.

 

Its only excepted income if a child beneficiary is involved. It is the beneficiary rather than trustee which complicates it and why the tax adviser to the trust should assist with the beneficiary tax to avoid error or inconsistency. The beneficiary must assess and report the excepted income flowing from the trust at A1.

If its adults their share is still "excepted" but ignored as such. Its a strange issue. You cant for example have $1m added by Grandma and then distribute the "grandpa share" to a child and grandma's share elsewhere. Its not unlike the super rule where tax elements pass through a estate or direct to a adult beneficiary and they are then subject to 17% tax.