I agree with Jeff that it may be necessary to speak with a financial advisor or a solicitor.
I see three potential issues.
1 Given that Harry has not (technically) owned the house for at least 10 years, are Harry and his wife even permitted to make “downsizer” contributions? (To me it looks like the answer is “no”, but it might be worth talking to the ATO or a solicitor; maybe the ATO would be prepared to take the view that Harry has owned the house since the date his mother passed away, for example).
2 Is capital gains tax due on the proceeds of sale of the house? (I cannot see how this can be the case: Harry and his wife have lived in that house for the whole of the time since they acquired it (whatever that date is deemed to be) so the “own residence” exemption would seem to apply.
3 If Harry downsizes, will the additional financial assets impact the assets and income tests and therefore affect the pension amounts payable? (In principle, this is always an issue and this would not appear to be affected by the special circumstances in which Harry acquired the house. Whether there will actually be a reduction in the pension amounts payable will depend on the amount Harry receives on the sale of his property, and the amount that Harry then spends on the downsized residence. The normal rules of the age pension assets and income tests would apply. It is not possible to provide a detailed answer to this question without knowing much more detail about Harry’s current situation.)
