Inheriting an Australian Estate as a Non-Resident: The CGT Trap Nobody Mentions

Inheriting something is usually a bittersweet moment, grief on one side, a small financial cushion on the other. What very few people expect is a tax bill arriving as part of the deal, triggered not by anything the beneficiary did, but simply because they happen to live overseas. Yet that’s exactly what can happen when a non-resident inherits certain assets from an Australian estate, thanks to a quietly brutal little provision called CGT event K3.

If you’re an Australian living abroad and you’re a beneficiary (or you’re the one writing a will with an overseas-based child or relative in mind), this is genuinely worth understanding, because the cost of not knowing tends to land on the family at the worst possible time. It all turns on tax residency, so it’s worth being clear on whether you (or the beneficiary) are an Australian resident for tax purposes in the first place. Here’s how it actually works, stripped of the jargon.

One scope note before we go further: this article is about CGT assets passing through a deceased estate. Assets that pass outside the estate, such as some jointly held assets, superannuation death benefits, life insurance proceeds, and assets held through companies or trusts, can follow quite different rules. Same family, different tax animal.

First, the normal rule: death usually doesn’t trigger CGT

Start with what normally happens, because the trap only makes sense against that backdrop. Under Australia’s main inheritance rule (in Division 128 of the tax law), when someone dies, any capital gain or loss on their CGT assets is generally disregarded at that point. Death itself isn’t treated as a sale. Instead, the legal personal representative or beneficiary is generally taken to have acquired the asset on the day the deceased died, and for many post-CGT assets the beneficiary effectively inherits the deceased’s cost base, so the unrealised gain is simply deferred until a later sale. There are important exceptions, though: pre-CGT assets, certain main residences, and some foreign-resident-deceased cases can use market-value rules instead. The rollover is generous, but it still came with a spreadsheet.

That’s the comfortable, familiar position, and for most Australian-resident beneficiaries it’s the end of the story for now. No immediate tax, deal with it down the track. But there’s an exception, and it’s pointed squarely at non-residents.

The exception: CGT event K3, and why it bites non-residents

Here’s the trap. Under section 104-215 of the tax law, a special CGT event (charmingly named “K3”) happens when a CGT asset passes from a deceased Australian resident to a beneficiary who is a foreign resident, but only where the asset is not “taxable Australian property.” When K3 applies, the comfortable death rollover is switched off. The event is treated as happening just before death, even though you may only know it applies once the asset actually passes to the foreign-resident beneficiary. The gain is worked out using the asset’s market value on the day of death, less the deceased’s cost base at that time. If the estate has already lodged the deceased’s final return before this becomes clear, amendment issues may need to be managed; tax law doesn’t always wait for the executor to find the good pen.

One technical word matters here: “passes.” An asset can pass to a beneficiary under the will, on intestacy, by the legal personal representative appropriating it to them, or under certain deeds of arrangement. It doesn’t pass merely because the executor sells it under a power of sale. That distinction can matter, because K3 looks at the beneficiary’s residency at the moment the asset passes, not just where everyone happened to be on the day of death, which is one more reason planning before assets are distributed beats scrambling afterwards.

Why does this rule exist? It’s not random cruelty (though it can feel that way). Normally, a foreign resident pays no Australian CGT on non-taxable-Australian-property assets. So if the rollover applied and a non-resident inherited, say, a parcel of Australian shares, the gain that built up during the deceased’s lifetime could slip out of the Australian tax net entirely once the non-resident eventually sold them as a foreign resident. CGT event K3 exists to stop that gain escaping: it catches the deceased’s accrued gain at the point of death, before the asset leaves Australia’s reach. The logic is defensible. The timing, for the family on the receiving end, can still be painful.

The crucial distinction: which assets get caught

This is the part the quick summaries usually garble, so let’s be precise. CGT event K3 only applies to assets that are not taxable Australian property. That distinction decides everything:

• Assets that are not taxable Australian property are the ones caught by K3. This often includes ordinary portfolio shares in Australian or foreign public companies, managed fund units, and assets located outside Australia. Don’t turn that into a slogan, though: shares or units can themselves be taxable Australian property if they’re substantial interests in land-rich entities, and Australian permanent establishment assets have their own rules. Ordinary portfolio shares are often caught by K3; land-rich interests are a different animal in the same zoo.
• Taxable Australian property is not caught by K3. This mainly includes Australian real property (land and buildings), certain indirect Australian real property interests, business assets used through an Australian permanent establishment, rights or options over those assets, and assets previously kept inside the Australian CGT net under the departure-election rules. These pass to the foreign-resident beneficiary under the normal rollover, because Australia keeps the right to tax them whenever a later CGT event happens, so there’s no need for K3 to grab the gain early.

So the headline is almost the reverse of what people assume: it’s often the share portfolio, not the Australian house or investment property, that triggers the immediate K3 problem for a foreign-resident beneficiary. The real estate isn’t “tax-free”; it’s simply kept inside Australia’s CGT net and dealt with on a later sale. The shares are just where the tax bill tends to turn up first. Very rude, and very real.

There’s also an exception for genuinely old assets: if the deceased acquired the asset before 20 September 1985, any K3 gain or loss itself is disregarded. Don’t get too comfortable, though, because pre-CGT shares or trust interests can still raise a separate issue called CGT event K6, where the underlying company or trust holds significant post-CGT property (broadly, where its post-CGT property is at least 75% of its net value). It doesn’t always apply, and there are exceptions (including for certain long-listed widely-held entities), but “pre-CGT” doesn’t automatically mean “nothing to see here.” Old assets are often easier; they aren’t always asleep.

(There’s also a separate exception for certain philanthropic testamentary gifts, but that’s its own narrow lane; this article stays focused on the foreign-resident beneficiary trap.)

Who actually pays, and where it’s reported

Here’s the bit that surprises people, and where the original quick advice on this topic is easy to misread. The K3 capital gain is treated as the deceased’s gain, not the beneficiary’s. It must be reported in the deceased person’s date-of-death tax return, their final return. The estate’s legal personal representative (the executor) is responsible for seeing that the final tax position is dealt with, and any resulting tax is effectively borne by the estate before the remaining assets are distributed.

The tax isn’t necessarily on the raw gain dollar-for-dollar, either: the deceased’s final return still works through the usual net-capital-gain machinery, so available capital losses, CGT discount eligibility and the other normal CGT rules can affect the result. That can soften the blow, though it can also mean digging up records for assets the deceased may have bought decades ago, which is precisely as much fun as it sounds.

In practice, the cost is usually borne by the estate as a whole, which (unless the will says otherwise) effectively reduces what’s left for everyone to share. So even beneficiaries who didn’t inherit the triggering asset can end up quietly wearing part of the cost, because the estate’s pool is smaller after the tax is paid. It’s the kind of thing that causes friction between siblings if nobody saw it coming, which is precisely why seeing it coming matters.

Can the hit be reduced? Yes, but it’s a job for the willmaker’s lawyer

This is where we have to be clear about lanes. There are genuine, legitimate ways to manage or reduce a K3 exposure, but most of them involve how the will is drafted and how the estate is structured, which is estate-planning and legal territory, the domain of the willmaker and their solicitor, not something a tax agent drafts or a beneficiary can fix after the fact. We can explain the tax consequences and work them through with you; the will and structuring sit with the estate’s lawyer.

With that boundary stated, the kinds of approaches that come up include: directing cash, or taxable-Australian-property assets, to the foreign-resident beneficiaries (since those don’t trigger K3), while leaving non-taxable-Australian-property assets like share portfolios to Australian-resident beneficiaries (though note that if the estate has to sell shares to create that cash, the sale can itself trigger CGT in the estate, so cash can avoid K3 without making asset sales invisible); using an Australian resident testamentary trust to hold the relevant assets (the ATO’s practice statement PS LA 2003/12 reflects its administrative practice of treating such a trustee like a legal personal representative for the Division 128 rules, which can defer a taxing point in the right case, but that practice is itself subject to CGT event K3, trust residency has to be managed, and later distributions still need close analysis, so it’s a structure with receipts, not a magic bucket); or building equalising or compensation arrangements into the will so the tax cost is shared fairly. Each of these has its own consequences and conditions, so they need proper legal and tax advice before being relied on. The one universal truth: this is far, far easier to plan before death than to untangle afterwards.

What happens to the beneficiary afterwards?

One piece of good news to balance the ledger. Once K3 has done its work and the estate has paid the tax, the foreign-resident beneficiary is generally in a cleaner position for Australian CGT purposes: if they later sell the asset while still a foreign resident, and it remains non-taxable-Australian-property, Australia will usually have no further CGT claim on that later sale. That’s the whole point of K3, to collect the deceased’s accrued gain before the asset leaves the Australian net. And if the beneficiary later becomes an Australian tax resident, section 855-45 may reset the Australian cost base of those non-taxable-Australian-property assets to market value at the time they become a resident (with exceptions, including for taxable Australian property, pre-CGT assets and temporary residents), so Australia isn’t trying to tax the same pre-residency growth twice. The broad idea holds, but the reset still needs checking asset by asset.

The bottom line

Inheriting from an Australian estate as a foreign resident usually isn’t a K3 problem for Australian real estate, because that property stays inside Australia’s CGT net and is dealt with on a later sale. The K3 problem sits in the assets people least expect: share portfolios, managed fund units and other non-taxable-Australian-property assets. When it applies, the gain is treated as the deceased’s, the event is taken to happen just before death, and the tax is dealt with in the deceased’s date-of-death return, so the estate pays and the whole pool can shrink unless the will deals with the cost clearly. It’s one of the least-known traps in Australian tax, and because it’s driven by where the beneficiary lives, it catches expat families more often than it should.

The good news is that it’s highly manageable with a bit of foresight, the right will drafting (with the estate’s solicitor) and the right tax advice (with us) before assets are transferred. The bad news is reserved entirely for the families who find out about it after the event. Don’t be one of those.

Inheriting, or planning an estate with someone overseas?

This is exactly the sort of cross-border tangle we help Australians work through. We explain how CGT event K3 and the inheritance rules apply to your situation, model the numbers, and coordinate with the estate’s solicitor so the tax side is handled properly rather than discovered too late. We work remotely with expats all over the world, and our fee is always an upfront quote.

Book an appointment with our specialist team today. Far better to know before than to find out after.

General information only. This article doesn’t consider your personal circumstances and isn’t tax, financial or legal advice, and nothing in it is a recommendation about how to structure a will or estate. We’re registered tax agents, not solicitors; will drafting and estate structuring should be done with a qualified estate-planning lawyer. The rules described (including CGT event K3 and the deceased estate provisions) are technical and depend on the specific assets, the residency of those involved and the terms of the will. Speak to our specialist expatriate tax team today, or to another registered tax agent, before acting.