Estate planning: passing on assets tax-effectively

For most of a lifetime, the goal is to build wealth. Estate planning turns to the next question: how to pass that wealth on to the people you care about, in the most tax-effective way. The good news is that Australia has no inheritance tax and no death duty. The less obvious news is that some assets carry tax with them — a hidden cost the beneficiary inherits along with the asset.

Two things in particular can surprise families. First, an inherited asset can come with a latent capital gains tax (CGT) liability that only crystallises when the beneficiary later sells. Second, the superannuation death benefit that passes to an adult child can be taxed, even though super is tax-free for the member in retirement. Sound planning is therefore about matching who inherits which asset, and structuring how they receive it.

Property is usually the largest asset in an estate, and the family home and an investment property are treated very differently for tax. Understanding the difference often shapes the whole plan.

The main residence

The family home — the main residence — is generally the most tax-effective asset to inherit. If a beneficiary sells within two years of the date of death, the sale is generally free of CGT. If instead they keep it, the property's cost base generally resets to its market value at the date of death, so only growth from that point is ever taxed. In some circumstances the “absence rule” can also preserve a property's main-residence status for a period even while no one lives in it — the detail depends on the facts.

An investment property

An investment property is different. The beneficiary inherits the deceased's original cost base — broadly what the deceased paid, plus the cost of any capital improvements. No CGT arises simply on inheriting the property. But when the beneficiary later sells, the whole gain — measured from that original cost — can crystallise at once.

Two practical points follow. Keeping good cost-base records is essential — original purchase documents and a history of improvements can be worth a great deal in tax saved years later. And who sells, and when, matters: a sale by the estate in a low-income year, versus a sale by the beneficiary later on top of their own income, can produce quite different tax.

After property, the share portfolio, superannuation and cash are the assets families most often ask about. Each has its own rule, and the differences between them shape which asset is best left to whom.

Shares

Shares are generally inherited at the deceased's original cost base, much like an investment property — the latent gain passes to the beneficiary. There is an important exception: pre-CGT shares, acquired before 20 September 1985, have their cost base reset to market value at the date of death, so the earlier growth is never taxed. One more point catches families out: capital losses cannot pass to beneficiaries. Because a loss dies with the holder, realising loss-making holdings during a person's lifetime — to offset other gains they have — is sometimes considered as part of a plan.

Superannuation — and the death-benefits “tax”

Superannuation does not automatically form part of the estate, and its tax on death turns on who receives it. The law sorts beneficiaries into two groups:

The withdrawal-and-re-contribution strategy

Because only the taxable component is taxed to adult children, a well-timed strategy can shrink it. Once you are over 60 and have met a condition of release (for example, reaching 65), you can withdraw super tax-free and re-contribute part of it as a non-concessional (after-tax) contribution — which lands in the tax-free component. Repeated over a few years within the caps, this re-contribution strategy can convert much of a taxable balance into tax-free, so adult children eventually inherit most or all of it without the death-benefits tax.

Cash

Cash is the simplest of all. It passes to beneficiaries with no tax — which is part of why which asset goes to whom is worth thinking about in advance.

Instead of leaving assets directly to a beneficiary, a will can create a testamentary discretionary trust (TDT) — a trust that comes into existence on death and holds the inheritance for the family. For many estates this is the single most valuable planning tool, and it offers three distinct advantages.

A TDT is not free of effort. It needs a properly drafted “testamentary trust will”, and once running it carries ongoing accounting and tax-return costs each year. Those costs mean a TDT is generally worthwhile for larger estates, or where asset protection or young beneficiaries make the structure especially valuable. Whether it suits a particular family is a question to work through with us and your estate-planning lawyer.

See, in rough terms, how splitting the income from inherited assets through a testamentary discretionary trust — across the adult child and the grandchildren — can reduce the family's tax compared with leaving the assets directly to the child. Adjust the figures for an indicative result.

Simplified illustration. It assumes each grandchild's distribution (up to the tax-free threshold) is taxed at $0 and any remainder is taxed at the child's marginal rate. Real outcomes depend on each beneficiary's own other income, and a distribution to a minor must be genuinely applied for that child's benefit. We model your specific situation precisely.

Estate planning sits at the meeting point of tax, superannuation and law. We work alongside your estate-planning lawyer on the tax side of the plan: structuring the will and any testamentary discretionary trust, keeping the cost-base records that protect your beneficiaries, modelling the income-splitting outcomes, and shaping the superannuation strategy — so the assets you have built pass on with as little tax as the law allows.

Talk to us Read the ATO's deceased-estates guidance

Testamentary discretionary trust

A discretionary trust created by a person's will that comes into existence on their death. The trustee decides each year who in the family receives the trust's income, allowing income splitting and offering asset protection.

Cost base

Broadly what was paid for an asset plus certain costs and capital improvements. It is subtracted from the sale price to work out the capital gain. A beneficiary generally inherits the deceased's original cost base.

Main residence exemption

The rule that generally exempts a person's home from CGT. On death, a beneficiary who sells within two years is generally CGT-free, or the cost base resets to market value at the date of death if the property is kept.

Capital gains tax (CGT)

Tax on the gain made when an asset is sold for more than its cost base. Inheriting an asset does not itself trigger CGT, but a latent gain can crystallise when the beneficiary later sells.

Pre-CGT asset

An asset acquired before 20 September 1985, when CGT began. On the owner's death its cost base generally resets to market value at the date of death, so the earlier growth is never taxed.

Excepted trust income

Income from a testamentary trust that is taxed in a minor's hands at ordinary adult marginal rates rather than the penalty rates that usually apply to a child's investment income, so the child can use the tax-free threshold.

Superannuation death benefit

The super balance paid out when a member dies. Its taxable component can be taxed when paid to a non-dependant, such as a financially independent adult child — commonly around 15% plus Medicare.

Death benefits dependant

For super death-benefit tax: a spouse (or former spouse), a child under 18, a financial dependant, or a person in an interdependency relationship. A benefit paid to them is tax-free; a financially independent adult child is not one.

Taxable component

The part of a super balance built largely from employer and pre-tax contributions and earnings. It can be taxed when a death benefit is paid to a non-dependant. (The tax-free component, largely from after-tax contributions, is not.)

Non-concessional contribution

An after-tax contribution to super for which no deduction is claimed. It adds to the tax-free component. It is capped each year (currently $120,000, or up to $360,000 under the bring-forward rule) and can generally be made only up to age 75.

Re-contribution strategy

Withdrawing super (tax-free after age 60, once a condition of release is met) and re-contributing it as a non-concessional contribution, converting taxable component into tax-free component to reduce the tax an adult child pays on a death benefit.

Enduring power of attorney

A legal document appointing someone to make financial (and sometimes other) decisions on a person's behalf, which continues to operate even if that person later loses capacity. A core part of a complete estate plan.