An Australian resident inherited a property from their deceased parent in 2020 valued at $400,000 and sells it in 2024 for $520,000. The property was the parent's principal place of residence. What is the cost base for CGT purposes?
Correct Answer
B) $400,000 - the market value at date of death
Under CGT rules, inherited properties receive a 'stepped-up' cost base equal to the market value at the date of death. This means the beneficiary's cost base is $400,000, and they pay CGT only on gains above this amount.
Why This Is the Correct Answer
Option B is correct because under Division 128 of the Income Tax Assessment Act 1997, inherited assets receive a 'stepped-up cost base' equal to the market value at the date of death. This means the beneficiary's cost base is reset to $400,000 (the property's value when inherited), not the original purchase price paid by the deceased parent. The CGT liability is calculated only on gains above this stepped-up cost base, so the taxable gain would be $120,000 ($520,000 - $400,000).
Why the Other Options Are Wrong
Option A: $0 - inherited properties have no cost base
This is incorrect because inherited properties do have a cost base under Australian CGT rules. The cost base is specifically set at the market value at the date of death, known as the 'stepped-up cost base'. Without any cost base, the entire sale proceeds would be subject to CGT, which would be unfair to beneficiaries.
Option C: $520,000 - the sale price
This is incorrect because the sale price cannot be the cost base. The cost base represents what you paid (or deemed to have paid) for the asset, while the sale price is what you received. Using the sale price as the cost base would result in zero capital gain, which contradicts the fundamental CGT calculation of sale price minus cost base.
Option D: The original purchase price paid by the parent
This is incorrect because the original purchase price paid by the parent is not relevant for the beneficiary's CGT calculation. Under the stepped-up cost base rules, the beneficiary's cost base is reset to the market value at death, not the deceased's original cost base. This prevents the beneficiary from being taxed on gains that occurred during the parent's ownership.
Deep Analysis of This Finance Taxation Question
This question tests understanding of Capital Gains Tax (CGT) cost base rules for inherited properties under Australian tax law. The 'stepped-up cost base' principle is fundamental to inheritance taxation, ensuring beneficiaries aren't taxed on gains that occurred during the deceased's ownership period. This rule prevents double taxation and recognizes that the beneficiary didn't benefit from the property's appreciation during the deceased's lifetime. The concept connects to broader estate planning strategies, where understanding CGT implications helps families make informed decisions about property transfers. In practice, this rule significantly impacts investment decisions, as inherited properties often have more favorable tax treatment than purchased properties. The market valuation at death becomes crucial, as it establishes the new cost base for all future CGT calculations, making professional valuations essential for estate administration.
Background Knowledge for Finance Taxation
Capital Gains Tax (CGT) applies to assets acquired after 20 September 1985. When someone inherits property, Division 128 of the Income Tax Assessment Act 1997 provides that the beneficiary receives a 'stepped-up cost base' equal to the market value at the date of death. This rule ensures beneficiaries only pay CGT on gains that occur after inheritance, not on appreciation during the deceased's ownership. The market value must be determined by a qualified valuer. CGT events A1 (disposal of CGT asset) and K3 (asset passing to beneficiary) are relevant. The main residence exemption may also apply if specific conditions are met.
Memory Technique
Remember 'STEP-UP' for inherited properties: 'Stepped-up cost base Takes Effect at Property's Underlying Price' at death. Think of it like stepping up to a new starting point - you don't carry the deceased person's 'baggage' (their original cost), you start fresh at the current market value when you inherit.
When you see inheritance questions, immediately think 'STEP-UP' and look for the market value at death as the cost base option. Eliminate any answers referring to original purchase prices or zero cost base.
Exam Tip for Finance Taxation
For inheritance CGT questions, always look for the market value at date of death as the cost base. Ignore the deceased's original purchase price and remember that inherited properties do have a cost base - it's just 'stepped-up' to current market value.
Real World Application in Finance Taxation
Sarah inherits her grandmother's investment property valued at $600,000 at death in 2023. Her grandmother originally bought it for $200,000 in 1995. When Sarah sells the property in 2024 for $650,000, she only pays CGT on the $50,000 gain ($650,000 - $600,000), not on the full $450,000 appreciation since 1995. This stepped-up cost base rule protects Sarah from being taxed on gains that occurred before she owned the property, making inheritance more tax-efficient than inter-generational gifts during lifetime.
Common Mistakes to Avoid on Finance Taxation Questions
- •Using the deceased's original purchase price as cost base
- •Thinking inherited properties have no cost base
- •Confusing sale price with cost base
- •Forgetting about the stepped-up cost base rule
- •Not considering market valuation at death date
Related Topics & Key Terms
Key Terms:
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