A common desire that parents (and other relatives) have is to make gifts to their children. This can have adverse tax consequences, but they can be eliminated with careful estate planning.
When one person gifts an asset to another, this will constitute a disposal for capital gains tax (CGT) purposes. The tax law states that when one person gives an asset to another and receives nothing in return, for tax purposes the giver is deemed to receive the market value of the asset at the time of disposal. The giver would make a capital gain if the market value of the asset exceeds the asset’s cost base.
Where a person buys an asset for the purposes of gifting it to another person, the giver would generally pay market value to acquire the asset immediately before making the gift. On that basis, the giver’s cost base in the asset would be equal to its market value, meaning that the giver would not make a capital gain or loss as a result of making the gift.
However, where a person gifts to another person an asset that they have already owned for some time, this would not be the case. The giver’s cost base in the asset would generally be based on the cost of the asset at the time of acquisition. If the asset has increased in value between the time of acquisition of the asset and the time of making the gift, the giver would make a capital gain on the basis that the market value of the asset at the time of disposal exceeds the cost base of the asset.
People suffering from terminal illness often feel motivated to make gifts, but this can lead to taxable capital gains as discussed above. In contrast, where assets pass from the deceased person to their beneficiaries under a will, no taxable capital gains arise. When the beneficiary ultimately disposes of the asset, a capital gain or loss arises at that time. Therefore, consideration might be given to making gifts under a will rather than before death in order to defer the CGT liability.
A beneficiary under a will would acquire the deceased’s cost base in the assets inherited if those assets were acquired after the commencement of the CGT law on 20 September 1985. If the deceased acquired an asset before that date, the cost base is equal to the market value of the asset on the date of death of the deceased person.
Different considerations may apply where a person suffering from a terminal illness has carry forward capital losses and assets with unrealised capital gains. Where a person dies with capital losses, the capital losses are lost and are not available in their estate or to a beneficiary of the estate.
However, if the person prior to their death makes a gift of assets with unrealised capital gains, the capital losses could be deducted against those capital gains. By so utilising the capital gains, the CGT liability of the beneficiaries is reduced when they ultimately dispose of the assets.
A further benefit is that the recipient of the gift is deemed to have a cost base equal to the market value of the assets at the time of the gift. In contrast, if the recipient of the gift had instead inherited those assets under a will, as discussed above, the recipient would inherit the unrealized capital gains on the assets and pay tax on those gains when the beneficiary ultimately disposes of the assets.
Carefully considered estate planning before a person dies can be very tax effective; this can be achieved cooperatively with the person’s solicitor. The loss of tax losses that may be worth of tens of thousands of dollars is never a good outcome.