Regal Legal

Testamentary Trusts and the CGT Main Residence Exemption for Family Homes: Draft Taxation Determination TD 2026/D1 and What It Means for Estate Planning

— Why the way a will deals with the “right to occupy” could affect the capital gains tax payable when a family home is later sold

A testamentary trust is one of the most common structures used to hold the family home after death — and for many families, that home is one of the largest and most significant assets in an estate. Estate planning conversations usually focus on how assets will be distributed after death, how to provide for a spouse and children, and whether a testamentary trust should hold and manage the estate.

But there is another question that is often overlooked:

If a spouse or child continues to live in the family home after the owner passes away, will the eventual sale of that home qualify for the Capital Gains Tax (CGT) main residence exemption?

In March 2026, the Australian Taxation Office (ATO) released Draft Taxation Determination TD 2026/D1, setting out an interpretation of the CGT main residence exemption for homes held in a deceased estate — one that estate planning practitioners and families alike should be paying attention to.

At the heart of the draft determination is this question:

What actually amounts to a “right to occupy the dwelling” under the deceased’s will?

The ATO has taken a relatively strict position: if the right of occupation is not granted directly by the will, but instead arises only because a trustee of a testamentary trust later exercises a discretion after death, that right may not satisfy the requirements for the CGT exemption.

TD 2026/D1 is currently still a draft — it is not settled law and not a final ATO ruling. Professional bodies including the Law Council of Australia and The Tax Institute have already raised concerns about the ATO’s approach.

This development does not mean every testamentary trust will lose the CGT exemption. What it does mean is that families undertaking estate planning should think carefully about how the family home is held, where the right to occupy comes from, and the precise wording of the will.

1. Why the deceased estate main residence exemption matters so much

Generally speaking, a qualifying main residence can be sold free of capital gains tax.

Once the owner of that home passes away, however, the property enters the deceased estate, and a separate set of CGT rules applies.

Section 118-195 of the Income Tax Assessment Act 1997 (Cth) sets out a specific CGT exemption for a dwelling held in a deceased estate.

Broadly, if the home was the deceased’s main residence at the time of death, and continues to be used as a main residence by an eligible person afterwards, the capital gain on eventual sale can be exempt in full or in part.

One category of “eligible person” is:

“an individual who had a right to occupy the dwelling under the deceased’s will”

In other words, if someone has a right to continue living in the home after the owner’s death — and that right was granted by the deceased’s will — this arrangement can be an important factor in whether the deceased estate main residence exemption applies, subject to the other statutory requirements.

So the question of who is entitled to keep living in the home is not purely a family matter — it can carry real tax consequences.

2. What does “right to occupy” actually mean?

Put simply, it refers to a right that someone acquires, under the deceased’s will, to live in the home after the owner’s death.

A will might state this expressly:

“My spouse shall have the right to continue to reside at my property at XXX until their death, until they cease to reside there, or until another specified event occurs.”

In that scenario, the right of occupation flows directly from the will itself.

The issue arises where the will instead establishes a testamentary trust structure.

For example:

1. The deceased’s will establishes a testamentary trust;
2. The family home is held by that trust;
3. The trust deed or the will gives the trustee a degree of discretion;
4. After death, the trustee then decides to let a particular beneficiary live in the home.

In practice, the person living there may well feel that their occupation flows from the overall estate structure the deceased put in place through the will.

However, the ATO’s draft view in TD 2026/D1 is:

Where the right of occupation only comes into being after death, through the trustee exercising a discretion — rather than being granted directly by the deceased’s will — that right may not satisfy the requirement of a “right to occupy under the deceased’s will.”

This is the single most significant part of the draft determination.

3. Why does this seemingly technical point create such a significant CGT problem?

The reason lies in the distinction between the CGT cost base of inherited property and the main residence exemption — two separate issues.

Suppose someone bought a home in 1995 for $400,000, and it remained their main residence throughout their life.

By the time they pass away, the property is worth $2 million.

If their children continue living there and the home is eventually sold years later for $3 million, whether the deceased estate main residence exemption applies can make an enormous difference to the tax outcome.

If the exemption applies in full, the qualifying capital gain can be exempt from tax entirely.

If it does not apply, the capital gain must be calculated under the ordinary deceased estate CGT rules.

In some circumstances, the property inherits the deceased’s original cost base, rather than resetting to market value at the date of death.

This means a family home held for decades, with an original purchase price far below current market value, could face a substantial CGT liability if the main residence exemption is lost.

This is why what looks like a narrow, technical question about how a right of occupation arises can, in practice, have a major impact on the final tax burden on an estate.

4. Does this mean testamentary trusts are a problem?

No, it does not.

Testamentary trusts are a well-established estate planning tool in Australia, used for a range of legitimate purposes, including:

• Long-term asset management for minor children;
• Asset protection in appropriate circumstances;
• More flexible distribution arrangements across family members;
• Estate planning for blended families;
• Allowing a trustee to manage the estate under pre-set terms;
• Aligning with a broader estate planning and tax planning strategy.

TD 2026/D1 is not saying:

“Placing the family home in a testamentary trust automatically means losing the CGT main residence exemption.”

The real question that needs to be analysed is:

how the home is held, how the right of occupation arises, and whether that right was granted directly by the deceased’s will itself.

That distinction matters a great deal.

5. How significant is the ATO’s draft position?

TD 2026/D1 is, at this stage, still a Draft Taxation Determination.

In other words:

• It is not legislation;
• It has not been passed by Parliament as new law;
• It is not yet a finalised ATO ruling;
• The final version may differ from the current draft.

That said, the draft is still worth taking seriously, because it reflects the ATO’s current thinking on how the relevant legislation should be interpreted.

More importantly, professional bodies have already made substantive submissions on this interpretation.

Law Council of Australia

The Law Council of Australia has raised concerns in its submission on TD 2026/D1 about the ATO’s sharp distinction between occupation rights arising from a testamentary trust and occupation rights that arise “under the will” itself.

One central point of contention is this:

If the testamentary trust itself was established by the will, and the overall occupation arrangement also flows from that will, should the involvement of a trustee exercising powers after death be enough, on its own, to say the right of occupation is not “under the deceased’s will”?

This is precisely the legal and tax question the profession is currently grappling with.

The Tax Institute

The Tax Institute has also raised concerns about the ATO’s draft interpretation, arguing that where the will itself has already established the occupation arrangement, and the testamentary trust is simply the vehicle used to carry it out, the exemption under s 118-195 should not be lost merely because a trustee is involved.

So there remains significant disagreement within the profession about the direction TD 2026/D1 is heading.

6. What are the practical implications for estate planning?

One of the most important takeaways from this development is:

Estate planning should not stop at deciding who receives which assets — it also needs to address how an asset is passed on, and who has the right to keep using it.

For the family home in particular, the following questions are worth thinking through carefully:

First, who will continue living there after death?

A spouse, an adult child, a minor child, or another beneficiary?

Second, where does that person’s right of occupation come from?

Is it granted directly by the will?

Or is it left to the trustee’s discretion after death?

Third, who holds the home?

Is it transferred directly to a beneficiary?

Or is it held through a testamentary trust?

Fourth, how long is the home expected to be held for?

If a sale is expected within two years, the relevant CGT rules may differ from a scenario where the home is held long-term.

If the family expects a spouse or children to keep living there for ten, twenty years or longer, the long-term CGT consequences deserve serious attention at the estate planning stage.

7. A simple comparison of two will structures

Structure one: the right of occupation is granted directly by the will

For example, the will might state:

The surviving spouse has the right to continue living at the nominated property after death, until a specified event occurs.

Here, the right of occupation is granted directly by the will.

This is more likely to satisfy what the ATO describes as a “right to occupy under the deceased’s will.”

Structure two: the will establishes a testamentary trust, and the trustee decides on occupation

Another common arrangement is:

The will establishes a testamentary trust, the home is held by the trustee, and the trustee has power to decide which beneficiary may use or occupy the property.

If the trustee only decides, after death, that a particular person will live there — based on the exercise of discretion — this may raise a problem under the ATO’s draft view in TD 2026/D1.

It’s worth stressing that whether this second structure actually loses the exemption is exactly what is currently being contested between the profession and the ATO.

So the two structures should not simply be treated as already producing two settled, different tax outcomes.

8. Does an existing testamentary trust need to be reviewed?

The fact that a family home involves a testamentary trust does not mean every such will needs to be changed immediately.

That said, the following situations are worth prioritising for an estate planning review:

• The family home is the main asset in the estate;
• The home carries a substantial unrealised capital gain;
• A spouse or children are expected to live there long-term after death;
• The home is expected to be held through a testamentary trust;
• The trustee has discretion over who may occupy the home;
• The existing will has not been reviewed for many years;
• The existing estate plan was drafted without specifically considering deceased estate CGT;
• The family intends to retain the home long-term rather than sell it shortly after death.

In these situations, rather than leaving the executor or trustee to sort out the problem after death, it makes more sense to review the will, the trust structure, and the associated CGT consequences while the will-maker is still alive.

9. Should you rush to amend your will because of TD 2026/D1?

A one-size-fits-all answer isn’t appropriate here.

TD 2026/D1 remains a draft, and the professional bodies have already made submissions challenging the ATO’s interpretation — so the final version may well change.

That doesn’t mean an existing estate plan can simply be ignored, though.

If the family home is a significant asset and is intended to be held through a testamentary trust, now is a sensible time to have it reviewed.

The point of that review isn’t simply “avoiding CGT” — it’s confirming:

1. Whether the will clearly expresses the testator’s intentions for the home;
2. Whether the right of occupation is created by the will itself;
3. Whether the testamentary trust’s terms are consistent with the will;
4. Whether the trustee’s discretion could affect the nature of the occupation right;
5. How the home is expected to be used after death;
6. What CGT consequences the current arrangement could produce if TD 2026/D1 is finalised in its present form.

10. Is this a “death tax”?

Some recent estate planning commentary has described this draft determination as a kind of “stealth death tax.”

From a legal and tax perspective, though, that description should be used with caution.

Australia does not currently have a general inheritance tax or estate tax.

What TD 2026/D1 deals with is how the CGT main residence exemption applies to a deceased estate — not a new tax the government has imposed simply because someone has died.

The real issue worth focusing on is this:

If a family had expected the main residence exemption to apply, but ultimately loses it because the right of occupation doesn’t satisfy the statutory requirement, the capital gain accumulated over many years could give rise to a real CGT liability.

“Death tax” may work as a media shorthand, but in a professional estate planning context, a more accurate way to put it is:

the ATO’s interpretation of the deceased estate main residence exemption may increase the CGT risk attached to some testamentary trust arrangements.

Conclusion: planning the family home in a will is about more than “who gets it”

The core issue TD 2026/D1 raises is not whether testamentary trusts are worth using. It’s this:

in estate planning, the ownership of the family home, the right to occupy it, and the tax consequences all need to be considered together.

A will is not just about deciding who gets which asset.

For the family home specifically, it’s also worth thinking about:

• Who is entitled to keep living there;
• Which legal document creates that right of occupation;
• Who holds the property;
• Whether it is held through a testamentary trust;
• What discretion the trustee has;
• And the CGT consequences when the home is eventually sold.

These questions matter even more where a home has been held for many years, has built up a substantial capital gain, and the family hopes the next generation will keep it for the long term.

TD 2026/D1 remains a draft, and the ATO’s final position — along with the legal consequences that flow from it — is not yet settled.

But for anyone who already has a testamentary trust in place, or is considering putting the family home into one, now is a worthwhile time to revisit the estate plan.

Key sources

Australian Taxation Office — Draft Taxation Determination TD 2026/D1
The ATO’s draft interpretation of “right to occupy the dwelling under the deceased’s will” in the deceased estate context.
ATO Legal Database — TD 2026/D1

Australian Taxation Office — Inherited main residence
Official guidance on the inherited main residence and deceased estate CGT exemption.
ATO — Inherited main residence

Australian Taxation Office — PCG 2019/5
Official guidance on the two-year sale rule for a deceased estate dwelling and related CGT treatment.
ATO — PCG 2019/5

Law Council of Australia — Submission on Draft TD 2026/D1
The Law Council’s submission on the ATO’s draft position and its impact on testamentary trust arrangements.
Law Council of Australia — TD 2026/D1 Submission

The Tax Institute — TD 2026/D1 consultation
Professional commentary on deceased estates, testamentary trusts, and the s 118-195 exemption.
The Tax Institute — TD 2026/D1 consultation

The Fine Print — June 2026
Further analysis of TD 2026/D1 and its estate planning implications.
The Fine Print — New ATO deceased estate rules

Disclaimer: This article provides general legal and tax information only and does not constitute legal, tax or financial advice. TD 2026/D1 is currently a draft, and the ATO’s final position and the legal consequences that follow from it may change. Individuals should seek appropriate legal and tax advice based on their own will, testamentary trust, use of the property, and other relevant facts.