Capital gains tax and the main residence exemption

Transcription

1 Capital gains tax and the main residence exemption FirstTech Most clients know that a capital gain made on the sale of their main residence is exempt from capital gains tax (CGT). However, things get more complicated when a dwelling is not used as a client s main residence throughout the entire, or is used to produce income. This guide clarifies the CGT rules and exemptions that apply to a client s main residence, including: what constitutes a main residence treating a dwelling as one s main residence during periods of absence calculating a CGT liability where a partial main residence exemption applies. This guide does not cover the special rules that apply when a dwelling is acquired or inherited from a deceased estate. For information about these rules, refer to CGT implications of inheriting a main residence. Full exemption Main residence exemption base case 1 Any capital gain or loss an individual makes from a CGT event that happens in relation to a dwelling they own or part-own is completely disregarded if the dwelling was their main residence, and was not used for income producing purposes, throughout their. For CGT purposes joint owners of a dwelling are treated as if they each own an equal share of the dwelling. The main residence exemption extends to adjacent land on the same title of up to two hectares (including the area of land immediately underneath the dwelling), provided the land is used primarily for private or domestic purposes. What is a main residence? While a client s main residence is generally the dwelling in which they live, the term main residence is not defined in tax legislation. Whether a dwelling is a client s main residence depends on the facts and circumstances of each case. The ATO will generally take the following factors into consideration when determining whether a dwelling is a client s main residence: the length of time they have lived there (note, there is no minimum time a person has to live in a home before it is considered to be their main residence) whether their family lives there whether their personal belongings are situated there where their mail is being delivered their address on the electoral roll the connection of services (eg phone, gas or electricity) to the dwelling their intention to occupy the dwelling. A dwelling is considered to be a client s main residence when their interest is acquired if they move in as soon as practicable. If there is a delay in moving in because of certain unforeseen circumstances (eg illness or re-location required by work) and the client moves in as soon as the cause of the delay is removed, the ATO may still treat the dwelling as the client s main residence from the time their interest is acquired. However, if the delay in moving into a dwelling is because it is being rented to someone else, the ATO does not consider that the taxpayer has met t the requirement to move in as soon as practicable. 2 In addition, a mere intention to construct a dwelling or to occupy a dwelling as a main residence, but without actually doing so, is insufficient. 3 If a client does not move into the dwelling when it first becomes practicable to do so, then the dwelling is not their main residence until they move in. In this situation, a partial CGT exemption will be available (refer to section below). 1 This exemption only applies to individual clients. Dwellings owned by a company or trust will not be eligible for the main residence exemption, with the exception of a special disability trust owning a dwelling that is the principal beneficiary s main residence. 2 Chapman v FC of T 2008 ATC; Caller & Anor v FC of T [2009 AATA 890] 3 Couch & Anor v FC of T 2009 ATC

2 Continuing to apply main residence exemption when it would otherwise cease A dwelling would normally cease to be a client s main residence for CGT purposes once they stop living in it. However, in some cases they can make a choice to continue to apply the main residence exemption after they move out. If the dwelling is not used for income producing purposes (eg, left vacant, or used as a holiday home) while the client is absent, it can continue to be treated as their main residence for CGT purposes for an unlimited time after they cease to live in it. The six year absence rule If a client vacates their main residence and uses it for income producing purposes while absent (eg, renting it out), it can continue to be treated as their main residence. However, to be eligible for the full main residence exemption the maximum period of time that it can be used to produce income during a period of absence is six years. A client is entitled to another maximum six-year period each time the dwelling again becomes and ceases to be their main residence. When to make this choice A client s choice to continue to treat a dwelling as their main residence in such situations does not need to be made when they move out or start using the dwelling for income producing purposes. Instead, the choice is made for the income year in which the CGT event happens to the property (eg, the year in which the contract of sale was entered into). Once this choice is made, a client cannot treat any other dwelling as their main residence during that period (the only exception to this rule is if the client is changing main residences). Example 1: Tim lives in a house for two years before being posted overseas for four years. The house is rented out during his absence. Upon returning to Australia, Tim moves back into the house for another 2 years before again being posted overseas for three years (again renting it out). Upon returning to Australia, Tim immediately sells his house. Provided Tim has not chosen to treat any other dwelling as his main residence for CGT purposes during his periods of absence, he may choose to treat the house as his main residence during both absences because each absence is less than six years. He can make this choice when preparing his tax return for the income year in which he sells the house. Example 2: Josh lives in a house for two years before being posted overseas for seven years. The house is rented out for the first five years of his absence, and is vacant for the remaining two years. Josh then sells the house immediately upon his return. Provided Josh has not chosen to treat any other dwelling as his main residence for CGT purposes during his period of absence, he may choose to treat the house as his main residence for the entire seven year period, because it was not used to produce income for more than six years. He can make this choice when preparing his tax return for the income year in which the he sells the house. Changing main residences If a client is in the process of moving from one home to another, and the new dwelling is acquired before the existing one is disposed of, both dwellings can be treated as their main residence for up to six months provided: the existing dwelling was their main residence for a continuous period of at least three months in the 12 months before disposal, and it was not used for income producing purposes at any time in the 12 months before disposal, and the new dwelling becomes the person s main residence. If a client s existing dwelling takes more than six months to sell, both dwellings are treated as their main residence only for the last six months before the existing dwelling is sold. In this case, if the client chooses to claim the main residence exemption for their new home from the time of acquisition, then their existing home would only qualify for a partial exemption. Treating land as a main residence Vacant land cannot be a client s main residence as it doesn t meet the definition of a dwelling and the client cannot reside on it. However, a special rule allows a client to treat land as their main residence for CGT purposes for up to four years if they are building a dwelling, repairing or renovating an existing dwelling, or finishing a partly constructed dwelling on the land. This rule only applies if the client moves into the dwelling as soon as practicable after the building or repairs are completed and continues to use the dwelling as their main residence for at least three months from that time. Partial exemption If a dwelling is a client s main residence during part of their and they are not eligible for a full main residence exemption, a partial CGT exemption may apply upon disposal. The proportion of the capital gain that is assessable is generally calculated by the following formula: Taxable proportion = Capital gain x n-main residence days Total days in Special cost base rule: home first used to produce income x Percentage of floor area not used as main residence When working out the capital gain, a special rule applies if a main residence is used to produce income for the first time after 20 August Under this rule a client is taken to have acquired the dwelling at its market value at the time it was first used to produce income 4. This rule only applies if: the dwelling was acquired on or after 20 September 1985, and the dwelling is the client s main residence, and they would have been entitled to a full exemption if they had sold the dwelling immediately before it was first used to produce income. When the above conditions are satisfied, this rule will automatically apply and the client cannot choose otherwise. 4 Where this rule applies and the client disposes of the dwelling within 12 months from when it was first used to produce income, the 50% CGT discount will not be available.

3 Example 3: Estelle purchased an apartment in Sydney for $300,000 under a contract that was settled on 1 September 1998, and moved in immediately. On 1 July 2002, she moved overseas and began renting out the apartment. The market value of the property at that time was $350,000. During the time she was overseas Estelle did not acquire another dwelling and continued to rent out the apartment. She returned to Australia in 2011, and sold the apartment for $650,000 on 1 December Under the home first used to produce income rule, Estelle is deemed to acquire the apartment at market value ($350,000) on 1 July She is then entitled to choose to continue to treat the dwelling as her main residence during her absence for a maximum of six years (between 1 July 2002 to 1 July 2008). As the dwelling has been used for income producing purposes for more than six years during her absence, Estelle is only eligible for a partial exemption. Her assessable capital gain would be worked out as follows: Gross capital gain: $650,000 $350,000 = $300,000 Taxable portion: $300,000 x (1248 days*/3440 days**) x 0.50*** = $54,419 * this is the number of non-main residence days between the period 1 July 2008 to 1 December ** this is the number of days from 1 July 2002 to 1 December *** 50% discount for holding the dwelling for more than 12 months. Example 4: Nathan purchased a property (his main residence) in vember 1995 for $250,000. On 1 August 2009, he started to use 40% of the property for an IT software business. At that time, the market value of the property was $350,000. Nathan decided to sell his property in July 2012 for $500,000. As Nathan was still living there and it was used partly for income producing purposes, he cannot get a full exemption. Nathan s assessable capital gain is worked out as follows: Percentage of use x (Proceeds Cost base) = Capital gain 40% x ($500,000 $350,000) = $60,000 Nathan is also entitled to reduce the capital gain by 50% as he has held the property for more than 12 months. Frequently asked questions If members of a couple each own a dwelling, can both properties qualify for the main residence exemption? Members of a couple who live together can only treat one dwelling as their main residence. If each member of the couple had their own main residence prior to living together, they can treat both dwellings as their main residence during that period, but only one dwelling can qualify for the main residence exemption once they start living together. Can the main residence exemption apply to each dwelling if members of a couple live in different dwellings? If members of a couple live apart in separate dwellings that both or either members of the couple own, each member must either choose one of the homes as the main residence for both of them (meaning the other dwelling will not be eligible for the main residence exemption for the same period) or nominate both properties as their main residences for the period (however only a partial exemption will be available on each dwelling). If members of a couple nominate to treat different dwellings as their main residence for a period, each spouse can only claim exemption on the dwelling that was their main residence. The percentage of the main residence exemption for the respective property is then determined based on their percentage. If their percentage is 50% or less of the home nominated, a CGT exemption would apply for that share. If their is more than 50%, the exemption is only half of the period the couple had different homes. This rule applies whether a spouse has sole or the couple owns the home jointly (either as joint tenants or tenants in common). What are the CGT implications of subdividing land where a main residence is located and selling the divided land separately? Subdividing land does not result in a CGT event if the owner retains both subdivided blocks (so generally no capital gain or loss arises at the time of subdivision). However, when the blocks are sold either jointly or separately in the future, there are CGT implications, with the cost base of each parcel of land being the cost base of the original land divided between the subdivided blocks on a reasonable basis. In the case of adjacent land, the main residence exemption can only apply if the same CGT event happens to the land and to the dwelling that is the owner s main residence. This means that a parcel of land that has been subdivided (and is now a separate CGT asset) cannot qualify for the main residence exemption. 5 5 Refer to ATO website: for examples on CGT implications of subdividing land.

4 Explanation of terms: Dwelling a dwelling is anything that is used wholly or mainly for residential accommodation. As well as a house, this can also include a unit in a retirement village, a strata title unit, a caravan, houseboat or other mobile home. Any land immediately underneath the dwelling is considered part of the dwelling. Ownership interest a client has an interest if they have: Land or dwelling a legal or equitable interest in it, or a right to occupy it Flat or home unit a legal or equitable interest in a strata title in the flat or home unit; or a licence or right to occupy the flat or home unit. Ownership period the period on or after 20 September 1985 when the taxpayer had an interest in the dwelling or in post-cgt land on which the dwelling is later built. Spouse another person (of the same or opposite sex): who the client is legally married to with whom the client is in a relationship that is registered under a prescribed state or territory law, or with whom the client lives on a genuine domestic basis as a couple. More information Contact FirstTech team on or firsttech@colonialfirststate.com.au. The information contained in this document is based on the understanding Colonial First State Investments Limited ABN , AFS Licence has of the relevant Australian laws as at 1 February As these laws are subject to change you should refer to our website at colonialfirststate.com.au or talk to a professional adviser for the most upto-date information. The information is for adviser use only and is not a substitute for investors seeking advice. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person, including Colonial First State or any other member of the Commonwealth Bank group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information. This document is not financial product advice and does not take into account any individual s objectives, financial situation or needs. Any examples are for illustrative purposes only and actual risks and benefits will vary depending on each investor s individual circumstances. You should form your own opinion and take your own legal, taxation and financial advice on the application of the information to your business and your clients. Colonial First State Investments Limited does not provide taxation advice. If anyone intends to rely on advice you give to satisfy liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law they should request advice from a registered tax agent /FS5385/0313

5 CGT implications of inheriting a main residence (directly or via estate) FirstTech For most clients, the family home is their most valuable asset and often makes up the majority of an inheritance. Depending on the circumstances, there may not be any capital gains tax (CGT) implications when a beneficiary disposes of a property inherited from a deceased client s estate where the property was the deceased s main residence at the time of death or for some period during the deceased s period of. However, this is not always the case, and depending on the circumstances there may be CGT payable by the beneficiary. Calculating a CGT liability in this situation can be difficult as the taxation rules that apply to this area can be confusing. This guide focuses on the CGT implications of inheriting a property that was the deceased s main residence prior to death either indirectly through the deceased s estate or directly as a joint tenant. For information on the CGT treatment of a main residence while a client is alive, please refer to Capital gains tax and the main residence exemption guide. You can also find further information about capital gains tax by referring to CGT fundamentals for individuals or Capital gains tax and deceased estates guide. Flowchart Is the property inherited by your client the main residence of the deceased? Was the property the main residence of anyone covered in Table 1? Did the deceased acquire the dwelling before 20 September 1985? Did your client dispose of the property within two years of the deceased s death? Refer to FirstTech CGT and deceased estates guide Was the property used for income producing purposes immediately prior to the deceased s death? Was the property income producing for less than 6 years and the deceased would have been eligible for the absence rule? From the deceased s death until your client disposes of the property, was it the main residence of anyone covered in Table 1? Any capital gain or loss fully disregarded. A partial exemption applies to any gross capital gain. Refer to partial exemption rules.

6 Table 1: eligible occupiers of deceased s main residence 1. The client 2. The spouse of the deceased immediately prior to their death (except if they were living permanently apart from the deceased) 3. An individual who had the right to occupy the property under the deceased s Will Partial exemption If your client is not eligible for a full exemption as per the diagram on the previous page, they may be eligible for a partial CGT exemption when they dispose of the property. The amount of capital gain or capital loss assessable to the client is calculated using the following formula: Gross capital gain or loss n-main residence days Total days The parameters non-main residence days and total days used in this formula depend on the specific circumstances of the situation. Please refer to Table 2 and Table 3 for further information. Table 2: applies if the property was not income producing immediately prior to the deceased s death Deceased acquired the dwelling: Prior to 20 September 1985 On or after 20 September 1985 Cost base to work out the capital gain or capital loss Market value on the date of death. If the dwelling was the main residence of the deceased just before death market value on the date of death. Otherwise, deceased s cost base on the date of death. n-main residence days Number of days in the period from the date of death until client s period ends when the dwelling was not the main residence of anyone in Table 1. Number of days in the period from the date of death until client s ends when the dwelling was not the main residence of someone in Table 1. + of days in the deceased s when the dwelling was not their main residence. 1 Total days of days from date of death of days from the acquisition of the dwelling by the deceased 1 Exclude any days where the deceased was able to treat the property as their main residence although not living there (eg the six year rule). Table 3: applies if the property was income producing immediately prior to the deceased s death Deceased acquired the dwelling: Prior to 20 September 1985 On or after 20 September 1985 and the dwelling was first income producing on or after 20 August Cost base to work out the capital gain or capital loss Market value of the property on the date of death. Market value of the property on the date it was first income producing. n-main residence days Number of days in the period from the date of death ends when the dwelling was not the main residence of the deceased or someone in Table 1. Number of days in the period from the date of death until ends when the dwelling was not the main residence of someone in Table 1. + of days in the deceased s when the dwelling was not their main residence. 3 Total days of days from date of death of days from when the dwelling was first income producing until the client s 2 Special rules apply to a dwelling that was first used for income producing purposes prior to 20 August Please contact the FirstTech team for further details. 3 Exclude any days where the deceased was able to treat the property as their main residence although not living there (eg the six year rule). Case study 1 Harry inherited a property from his mother ra when she passed away in ra purchased the property in 1992 and it was her main residence throughout her entire period up until her death. Harry rented out the property after ra s death before selling it 18 months after ra s death. Any capital gain Harry incurred on the disposal of the property would be fully exempt. The period that the property was used to produce income after death does not affect the full exemption as long as Harry sold the property within 2 years of ra s death. Variation of case study 1 Assuming the same facts as case study 1 however in this case Harry sold the property four years after ra s death and rented it out throughout his entire. Part of the capital gain is assessable to Harry in the year he sold the property. The cost base to work out the amount of gross capital gain is the difference between the proceeds and the market value of the property on the date of ra s death. The gross capital gain is then apportioned by non-main residence days of 4 years over total days of 22 years (combined of ra and Harry).

7 Case study 2 Susan inherited her father Jack s main residence when he passed away in Jack bought the property in 1990 and it was his main residence until 3 years prior to his death when he moved into an aged care facility. The property was rented out immediately after Jack entered aged care and remained income producing until Susan sold it in 2010 (one year after Jack s death). Any capital gain Susan incurred on the disposal of the property would be fully exempt, despite the fact that the dwelling was income producing immediately before Jack s death. This is because Jack could have applied the 6 year absence rule 4 to continue to treat the dwelling as his main residence and Susan disposed of the property within two years of his death. Variation of case study 2 Assuming the same facts as case study 2, however in this case the property was income producing for 8 years immediately prior to Jack s death. Susan then sold the property one year after Jack s death. Part of the capital gain is assessable to Susan in the year she sold the property. The cost base is the difference between the capital proceeds and Jack s cost base on his date of death. Given the property is a post CGT asset, Jack s cost base is generally the amount he paid for the property. Susan s gross capital gain is then apportioned by the non-main residence days over the total days. When working out the non-main residence days Susan can exclude the first six year period the property was income producing after Jack vacated the property. When working out the number of total days it is the number of days from the date Jack first used the property to produce income until Susan sold it. More information Contact FirstTech team on or firsttech@colonialfirststate.com.au 4 Refer to FirstTech CGT Main Residence Guide for detailed explanation of the 6 year absence rule. The information contained in this document is based on the understanding Colonial First State Investments Limited ABN , AFS Licence has of the relevant Australian laws as at 1 February As these laws are subject to change you should refer to our website at colonialfirststate.com.au or talk to a professional adviser for the most up to-date information. The information is for adviser use only and is not a substitute for investors seeking advice. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person, including Colonial First State or any other member of the Commonwealth Bank group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information. This document is not financial product advice and does not take into account any individual s objectives, financial situation or needs. Any examples are for illustrative purposes only and actual risks and benefits will vary depending on each investor s individual circumstances. You should form your own opinion and take your own legal, taxation and financial advice on the application of the information to your business and your clients. Colonial First State Investments Limited does not provide taxation advice. If anyone intends to rely on advice you give to satisfy liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law they should request advice from a registered tax agent /FS5386/0313