When it comes to estate planning, dealing with the family home in the will always requires special consideration, especially where the willmakers are a couple and they are using testamentary trusts which will come into effect on the death of the first spouse (see my blog post Estate planning for couples: When should a testamentary trust start?).
For many willmakers, the family home represents their largest asset, and it is critical to understand how the home is owned and where it will pass on death when incorporating testamentary trusts in the will – if you’re not sure when to use testamentary trusts, check out my blog post 7 types of people who should use a testamentary trust.
Often the decision about where the family home should pass (i.e. to the surviving spouse outright or to them via the testamentary trust) requires a balancing of the tax and asset protection objectives of the willmakers.
As a general rule of thumb, if the willmaker trusts the surviving spouse to obtain appropriate advice upon re-partnering (for example, entering into a binding financial agreement) and there is no bankruptcy exposure for the surviving spouse, then the simplest approach is to leave the home directly to the survivor.
While it will always depend on the willmakers’ specific circumstances, some guidelines about how to deal with the family home are set out below.
Surviving spouse does not require asset protection
In the absence of the need for asset protection, it is often simplest for the purposes of land tax, negative gearing and simplifying access to the principal place of residence capital gains tax (CGT) exemption for the home to pass the home directly to the surviving spouse (instead of into a testamentary trust controlled by that surviving spouse).
Of course, where the home is held as joint tenants, it will pass automatically to the survivor regardless of what the will says. This usually provides a relatively neat outcome, as the bulk of the wealth will pass into the testamentary trust to access all those fantastic asset protection and tax planning advantages (see my previous blog post Testamentary trusts: worth every dollar or over complicating things? for a refresher), however, the principal place of residence CGT exemption can be easily maintained for the home.
Where the property is owned 100% by one spouse or as tenants in common, the will should specifically gift the home to the surviving spouse.
Finally, when the survivor ultimately dies, the home can then pass into the testamentary trust and either be converted into an investment property, or disposed of within two years of death generally tax-free.
Surviving spouse requires asset protection
Where asset protection is important (e.g to protect against the risks of the surviving spouse re-partnering or if there is bankruptcy exposure), the willmakers should consider passing their interest in the home into the testamentary trust immediately on death of the first spouse (or at least the deceased’s 50% interest in the home if it is held 50/50 as tenants in common).
The general rule is that the principal place of residence CGT exemption is not available where a home is held by a trust. However, it is still possible to access this exemption if the home passes into a testamentary trust, provided there is a right to occupy granted to the surviving spouse by the trustee of the testamentary trust (which will often be the surviving spouse anyway). The provisions of the testamentary trust should permit the trustee to grant rights to occupy the assets of the trust, and ideally, the will should expressly grant the surviving spouse a right to occupy the home.
This approach should permit the surviving spouse to still access the principal place of residence CGT exemption if the trustee decides to dispose of the home, whilst still protecting the interest in the home held by the trust.
As a word of caution – it is more complicated to access the CGT exemption when the home is held by a testamentary trust (by relying on section 118-195(2) Income Tax Assessment Act 1997 (Cth), ATO ID 2006/34 and ATO ID 2004/882) compared to the home being owned outright by the surviving spouse. If simplicity is of importance to the willmakers, they will have to weigh this additional complication against the benefits of asset protection. While it is possible to gift the home directly to the surviving spouse and implement a gift and loan back arrangement (a topic for another blog post), the downside of this approach is that they will have to wait out the 4.5 years bankruptcy clawback period. The clawback period does not apply when the asset is transferred into a trust under the will and protection begins immediately.
For completeness, if the home is held as joint tenants and the intention is for an interest in the property to pass into the testamentary trust in the first instance, then an additional step of converting the joint tenancy to tenants in common will also be required. This is a reasonably straightforward process with stamp duty and CGT exemptions available provided the underlying percentage ownership interests in the property does not change.
I love a good summary, so here goes:
Leave the home to the survivor in the first instance where:
- Simplicity is paramount
- Surviving spouse has no bankruptcy exposure
- Surviving spouse is trusted to take appropriate precautions for new relationships
- Surviving spouse can have autonomy over the home
Leave the home to a testamentary trust where:
- Asset protection is more important than simplicity of accessing the principal place of residence CGT exemption
- Surviving spouse has bankruptcy exposure
- Surviving spouse should not have control over the home or cannot be trusted to take appropriate precautions on re-partnering
While I hope the above guidelines will be of assistance, it is always a matter of weighing up the tax and asset protection objectives in consultation with the willmakers to determine which is going to be the most appropriate for their circumstances.