Your inheritance will likely be a house. What should you do with it?
Implications of inheriting or bequeathing property.
Millennials are set to become the richest generation in history when an estimated $90 trillion of wealth is passed on.
The intergenerational wealth transfer has been a pervasive discussion since the report by global property consultant Knight Frank was released. The report estimated that $90 trillion is expected to be transferred over the next 20 years.
However, when this transfer happens, it won’t just show up in bank accounts. When we look at where Australian wealth is held, two thirds of it is in residential property. It is likely that many beneficiaries of the intergenerational wealth transfer will receive the majority of their inheritance in bricks and mortar.
There are some situations where there will be exceptions. Australians are often going into older years with chronic illnesses and many will face the need for full time care. To afford full time care and nursing homes many people will tap home equity or sell their house.
In saying this, many millennials will be receiving a house as their inheritance. There are consequences and considerations around how a transfer should be structured. Most are tax related but there are other factors to consider. It is likely that you will have a sibling or other beneficiaries that the estate is split with. Unlike other assets like shares and cash that can easily be split down the middle, housing presents some issues.
Almost half of all wills in Australia are contested. Wills contested on the basis of a Family Provision Claim have over a 70% likelihood of being successful. Even if the will is specific in allocation, it can be contested on a needs-basis. This can add complexity if a beneficiary is living in the house in question.
Many people will have to navigate this complexity at an already emotionally charged time. Here are some of the considerations to inheriting a house.
Primary place of residence
If the house was a primary place of residence valuation is performed at the time of the owner’s death. Capital Gains Tax (CGT) will apply based on this value. However, there is a bit of breathing room. As it is the primary place of residence, you will have two years to dispose of the property and maintain the CGT-exemption.
If you don’t dispose of the property within two years, you will pay CGT based on the value of the property at the time of the owner’s death.
Two years can pass quickly when dealing with selling a loved one’s property. You will have to clean out the property, store, sell, donate or discard possessions. The property will have to be marketed and sold. It is important that any beneficiaries are on the same page about the timeline to sell the property with the ATO imposed timeline.
You are also able to extend the CGT-exemption period by making it a beneficiary’s primary place of residence before the two year period lapses.
An example is illustrative. A parent passes away and the house is valued at $800,000 at the date of death by a probate and deceased estate valuer. It takes two years to get the house in order, but the daughter of the deceased wants to do minor renovations on the place over the course of the next year before they sell.
Three years after the death, the house is now valued at $900,000. If she moves into the place and it is her primary place of residence, CGT is still not applicable on the property. If she does not move into the property, there is a capital gain of $100,000 where tax is applicable.
Investment properties or places of business
The rules for properties outside of the primary place of residence (PPR) are split into two categories based on the purchase date. Properties that are purchased before 1985 are valued at the time of the owner’s death. Properties that are purchased after 1985 have a cost basis of the original purchase value, and CGT must be paid on all unrealised gains. This could be a significant liability as houses have appreciated significantly in Australia over the last 30 years.
If the property is tenanted at death, the rent received will attract income tax.
Now that the tax considerations are out of the way, it is important to understand the other nuances with receiving a property as inheritance.
Multiple beneficiaries
As previously mentioned, it is likely that you are going to receive a house along with multiple beneficiaries. The number of contested wills shows that this does not always go in the right way. There is no way to predict how people will act when the assets of a will are being disbursed. The case of a daughter getting a share of her father’s estate after planning to kill him is a perfect example. The chances of conflict are greater if intentions aren’t completely clear and understood by all parties. There may still be a conflict even if everybody is in agreement during estate planning.
There are a few options if conflicts arise regarding future plans for the property. The most common are:
- Buying out other beneficiaries: a mortgage can be taken out by a beneficiary to buy out other beneficiary/ies if they want to keep the property
- A private agreement: A solicitor can help with drafting a private agreement where a beneficiary who wants to keep the property but avoid the extra costs of the mortgage, will make direct payments to the other beneficiaries over time.
- Sell the house: Unfortunately, the easiest solution is to sell the house if the parties are not in agreeance about the future of the property. If the beneficiary that is looking to keep the property cannot afford to buy out the other beneficiary/ies (or arrange a private agreement), a sale is the only logical conclusion.
The property still has a mortgage attached to it
The inheritance becomes even more complicated when there is a mortgage attached to the property. Many beneficiaries are forced to sell a property when they’re not able to service the mortgage. Another layer of complexity is if you have multiple beneficiaries that have varied financial circumstances. Some may be able to afford their portion of the mortgage, others may not be able to.
Sentimental and emotional toll
If you inherit a house, it is likely that you have memories attached to the house and the people who inhabited it. Unlike other assets like shares and cash, a house may be emotionally difficult to let go. This can cause conflicts if multiple beneficiaries are involved and want different outcomes for the house.
The ATO can dictate what is the most efficient way to dispose of an asset, but it is important to acknowledge that this timeline doesn’t always align with the grief of losing a loved one and the logistics involved in selling a house. It is a difficult time for many people and loss is not always about rushing to the finishing line. Understand what works for you and how to move through the process in the best way for all beneficiaries.
Three tips to making this process easier
Mitigate risk with a will
Although wills aren’t iron-clad, ensuring that the owner of the estate has professionally prepared legal documents that are regularly updated will mitigate risk. There are several important considerations. The most common issue faced is when assets are gifted in a Will that aren’t properly structured to pass on. Beneficiaries can face complications if the house is held in a different ownership structure (common with investment properties). Or, if the house has multiple owners. Comprehensive estate planning will help make the process smoother for all parties.
Have a discussion and make intentions are made clear
Encourage a conversation where the intentions of the will are verbalised. Although this has no legal validity, it will give a clear reference point to the wishes of the deceased and a starting point for constructive decisions about how these assets will be handled when the owner dies.
Nothing is certain, ensure you do not count your chickens before they hatch
We recently released an episode of Investing Compass where we spoke about how to incorporate a potential inheritance into a financial plan.
The short answer is – don’t. Regardless of what happens with any inheritance, ensure you are in a position where you are not reliant on it to achieve your financial goals. If it does not eventuate, you won’t have to dig yourself out of a hole you can’t get out of.
