Overview of the Deceased Estate 3-Year Rule

The deceased estate 3-year rule provides specific tax concessions for the administration of the estate within the first three income years after the date of death. Here’s how it works:

• Main Residence CGT Exemption: Generally, the sale of assets within a deceased estate triggers a capital gain or loss. If the property is considered the deceased’s main residence and sold within two years of the deceased’s death, it is exempt from CGT. In some cases, this two-year period can be extended. However, the CGT exemption will not apply if the property was used to produce income.
• Income Tax Rates for the First Three Income Years: For tax purposes, the Australian Taxation Office (ATO) allows the income generated by a deceased estate during the first three income years to be taxed as assessable income at the individual income tax rates (including any tax-free thresholds) rather than the higher rates applicable to trusts (including being liable to pay the Medicare Levy). This can significantly reduce the tax liability for the estate and the beneficiaries.
• Tax Obligations Beyond the Third Income Year: If the estate administration extends beyond the third income year, the estate no longer qualifies for these special tax concessions. The estate’s income will be taxed at the higher trust tax rates, which can increase the overall tax payable. Therefore, finalising the estate’s affairs within three years is beneficial to take full advantage of the tax benefits.
• Other Exemptions: Some assets and income types may enjoy other exemptions. For instance, superannuation death benefits paid directly to dependents are generally exempt from tax, whereas non-dependent beneficiaries may have to pay tax on these benefits.

Timeline for the Deceased Estate 3-Year Rule

The 3-year rule is crucial for managing the tax obligations of a deceased estate. This rule affects how the estate is treated for tax purposes and offers specific benefits that can help minimise tax liabilities.

First Income Year

• Start Date: The first income year begins on the date the deceased died. 
• End Date: This period ends on the next 30th of June.
• Tax Treatment: During this time, the deceased estate earns any income and is taxed at individual income tax rates, which can be lower than trust tax rates. This income must be reported in the first trust tax return.
• Concessional Rate of Tax: The estate can benefit from the full tax-free threshold and concessional rebates, such as the low-income tax offset.

Second and Third Income Years

• Duration: The second and third income years follow standard financial years, running from 1 July to 30 June.
• Income Reporting: Any income, including capital gains from the sale of deceased estate property, must be included in the tax return for the deceased estate. Tax rates apply as if the estate were an individual that continues to benefit from tax-free thresholds and tax offsets.
• Property Sales: To take full advantage of tax exemptions, it is often beneficial to sell the deceased’s main residence within two years of the date of death. This can exempt the estate from paying CGT on the sale, providing significant tax savings.

Beyond the Third Year

• Tax Changes: If the estate administration process extends beyond the third year, the estate may lose its concessional tax treatment. The trust pays tax at higher rates, similar to those for trusts, rather than individual income tax rates.
• Seek Professional Advice: Due to the complexity of tax regulations beyond this period, it is essential to seek professional advice to manage the estate’s financial situation effectively and to minimise tax liabilities.

Lodging a Trust Tax Return for a Deceased Estate

Lodging a trust tax return is a critical part of administering the estate, ensuring compliance with the ATO and proper distribution of assets to beneficiaries.

Initial Steps

• Legal Personal Representative: The executor or administrator, acting as the legal personal representative, is responsible for lodging the tax returns for the deceased estate. This individual must gather all relevant financial information about the estate.
• ABN Registration: If the deceased estate continues to operate a business, it must apply for an Australian Business Number (ABN).

Income Reporting

• Income Year of the Deceased: The first trust tax return covers the period from the date of the person’s death to the end of that financial year. Subsequent returns follow the standard income years.
• Taxable Income: All income earned by the estate, including rental income from investment property and capital gains from the sale of estate property, must be reported. This includes any taxable income the deceased estate earned during the year.
• Tax Rates and Offsets: The estate can benefit from concessional tax rates and tax offsets during the first three income years. The tax rates apply similarly to individual income tax rates, potentially reducing the tax payable.

Filing the Return

• Required Documentation: The return needs to be lodged with supporting documentation, including details of all assessable income and any deductions claimed. This may include interest, dividends, rent, and capital gains.
• Professional Assistance: Given the complexities involved in preparing and lodging a trust tax return, it is advisable to seek professional advice and assistance from estate planning professionals who can engage other professionals, such as accountants, where necessary. Estate planning professionals can help ensure all obligations are met and the tax return is accurate and complete.

The Key Takeaways

Understanding the deceased estate 3-year rule is important for minimising tax on deceased estates. Beneficiaries are exempt from paying CGT on the sale of the deceased’s main residence if the executor sells the property within two years from the deceased’s death. Beneficiaries can also benefit from the administration of an estate being concluded within 3 years of the deceased’s death by leveraging concessional tax rates (including benefits of tax offsets) before being distributed in accordance with the deceased’s wishes. Always seek professional advice to navigate the complexities and maximise the benefits of the estate administration process.

Liability limited by a scheme approved under Professional Standards Legislation.

Disclaimer: the information in this article relates to NSW law as at the date it was written and is general information only. It does not constitute legal advice and should not be relied upon as legal advice. It may contain information or links to sources which are no longer current. If you have a question or legal issue, we recommend you contact a lawyer and obtain legal advice that takes into account your specific facts, circumstances, needs and objectives.