Explaining some of the common misconceptions about downsizer contributions, as well tips and traps to help maximise this opportunity.

Since its announcement, the downsizer contribution has continued to draw attention as a unique opportunity to help older Australians maximise their retirement savings. However, the rules around making a successful downsizer contribution are often misunderstood. This article explains some of the common misconceptions about downsizer contributions, as well as offering some tips and traps to help maximise this opportunity.

Basic rules

At a high level, a downsizer contribution can be made when the following conditions have been met.

– The individual is age 65 or over at the time they make the contribution;

– The individual, their spouse or former spouse has sold an interest in a dwelling they have held for 10 years – which is not a caravan, houseboat or other mobile home;

– The gain/loss from the sale is at least partially disregarded under the main residence capital gains tax (CGT) exemption; and

– The contribution is made within 90 days of settlement, and the appropriate paperwork is given to the super fund at or before the time the contribution is made.

The maximum downsizer contribution is the lesser of $300,000 per person or the proceeds received from the sale of the interest in the property. The amount contributed into super is exempt from the non-concessional contributions (NCC) cap.

What does it mean to downsize?

One of the most common misunderstandings in relation to downsizer contributions is that no downsizing needs to occur. The eligibility criteria simply require the sale of a property, which receives at least a partial main residence CGT exemption – what happens after the sale is irrelevant. A client can even ‘upsize’ their property and still make a downsizer contribution, or they can use the sale of the home as an opportunity to undertake a withdrawal and recontribution strategy by recycling money out of super and recontributing as tax-free downsizer contribution monies, if they do not have any excess funds from the sale of their home.

Social security concessions

When the downsizer contribution was announced, it was confirmed that amounts contributed under the downsizer rules would not receive any specific social security concession. However, there has been discussion as to whether amounts contributed under the downsizer rules could benefit from existing social security rules.

There is an existing concession which allows the proceeds from the sale of a home to be exempted from assets testing for 12 months (and in some cases, longer) where those funds are intended to purchase a new residence. The key is ensuring the intention is genuine. As Centrelink has the power to determine when the client ceases to intend to use the money to purchase a new residence, actions such as investing in longer term assets, may indicate the intention to purchase a new home is questionable.

Subdivision of the family home

Many properties that have been owned for a long period of time are situated on larger blocks of land, and as populations grow, these older blocks may provide a significantly higher sale value if they can be divided into two, or more, separate titles for sale.

So, does the subdivision of land impact the ability to make a downsizer contribution? Yes, it potentially can. Let’s consider a subdivision where the owner splits his existing home into two properties; one with the original dwelling in which the family continue living, and a second vacant block.

Main residence CGT exemption impacts

The subdivision itself is not a CGT event, and each underlying parcel is taken to have been acquired at the time of the original property purchase, with the cost base apportioned between them on a reasonable basis – so the 10-year condition is met. However, under the Income Tax Assessment Act 1997, section 118-165 the main residence exemption is not available to adjacent land that is sold separately to the dwelling itself. This means that if the vacant block is sold separately to the block with the home, no main residence CGT exemption applies.

What if both blocks are sold at the same time? The requirements for a downsizer contribution include that an ownership interest in a ‘dwelling’ is disposed. Dwelling is a term defined in the Income Tax Assessment Act 1997, section 118-115 to mean a unit of accommodation that is contained in a building and consists mainly of residential accommodation, as well as the land immediately under the unit of accommodation.

Using this definition, the block with the home retains a dwelling while the second block does not. However, as the adjacent land, being the vacant block, is being sold in the same transaction as the home it may, in some situations, be possible to extend the main residence exemption using the Income Tax Assessment Act 1997, section 118-120 to this second block. In this situation, the total proceeds of the sale of both blocks are considered in determining the amount which could be contributed as a downsizer contribution.

Multiple main residences

If the client was to build a dwelling on the second block and live in the new dwelling as their main residence, this could allow the client to choose which property is able to be used to fund the downsizer contribution, as both properties would qualify for a partial main residence exemption – at least in theory. A problem arises with whether the profits from the subdivision are now to be recorded on capital or revenue account and therefore, potentially treated as ordinary income. The ATO will treat the amount as profit and proceeds as income if:

• the intention of entering into the transaction was to make a profit, and
• the transaction was entered into either:
  • in the course of carrying on a business, or
  • in the course of carrying out a business operation or commercial transaction.

The ATO in taxation ruling 92/3 outlines the requirements for a transaction to be considered a business operation or a commercial transaction to include the nature and scale of activities undertaken, the amount of money involved, the complexity and scale of the operation and the manner in which the transaction has occurred. No single factor will determine whether the transaction meets this threshold, so clients should consider obtaining tax advice or a private binding ruling to be completely clear on whether their subdivision and build will be captured on the capital account or the revenue account.

What if the home is destroyed?

In situations where a home is destroyed, the owner may not wish to rebuild but instead simply move on by selling the remnants of the property without subjecting themselves to the stress of building a new residence upon it.

In this situation, the Income Tax Assessment Act 1997, section 118-160 allows the main residence exemption to apply, even though no dwelling is on the property. However, the downsizer contribution requirements are explicit in that what needs to be disposed is a dwelling, as described above.

There are allowances within the downsizer contribution rules for properties that have been compulsorily acquired and a replacement property obtained, however, there is no equivalent relief to ‘deeming’ a dwelling to be on a property in the case of destruction of the previous home.

In such situations, the client will need to construct a new dwelling on the property to qualify for a downsizer contribution.

Retirement living and downsizers

Retirement villages continue to grow in popularity among older individuals, and with increasing life expectancies and facilities providing opportunities for residents to ‘age in place’, the average length of a stay in retirement living arrangements appears to be growing.

Generally speaking, a retirement village does not give you a freehold title to the home, but rather a long-term leasehold interest. To qualify for the main residence exemption, as well as the downsizer contribution, you need to have disposed of an ‘ownership interest’ in a dwelling.

Fortunately, the definition of ownership interest in the Income Tax Assessment Act 1997, section 118-130 is quite broad. You are taken to have an ownership interest in a dwelling if you have a legal or equitable interest in the land on which a dwelling is erected, or in the case of a home unit, an interest in a stratum unit, a share in a company that has the legal ownership of the land on which the dwelling sits with an accompanying right to occupy it, or a licence or right to occupy the flat or home unit.

Generally, the rights afforded under a retirement village agreement give you a right to occupy a specific unit, so most arrangements would meet the ownership interest threshold.

However, not all retirement villages are equal. For the downsizer contribution, the ownership interest cannot be in a dwelling that is a caravan, houseboat or other ‘mobile home’ – none of which are defined, so their ordinary meaning is to be taken. Certain retirement villages allow you to purchase outright a discrete unit of accommodation, however, the purchase does not come with any rights to the land on which the unit sits, so the owner is instead required to pay site fees to rent the land.

This specific accommodation arrangement is able to be moved, and under various state laws, these dwellings are given special allowances by being designated ‘mobile homes’. There are Centrelink benefits for clients who live in these mobile home parks, as well. As an example, the purchase of the dwelling will provide security of tenure for the homeowner test, while the fact they are living in a mobile home also allows pensioners to receive rent assistance in some cases.

Clients living in these mobile home park arrangements may find themselves missing out when it comes to a downsizer contribution, as the dwelling may be categorised as mobile and does not qualify.

Multiple amounts received for purchase

The average property sale will involve the purchaser paying a deposit at the time of signing the contract, with a second settlement amount paid at the time the title of the property is transferred. In such a case, the seller will usually receive the net proceeds as a single amount at settlement, however, in some states, it is possible to release the deposit before settlement.

The downsizer contribution rules allow for multiple contributions to be made in relation to one sale, however, there is also a requirement that the contribution is made within 90 days of the change of ownership occurring. For the above scenario, this timeframe is easy to meet, but sometimes less common purchase arrangements, such as vendor financing, can involve sale proceeds being received well after the actual change of ownership.

While some clients may be limited by the 90-day timeframe to make their downsizer contribution, there is a specific statutory discretion that allows the ATO to extend the 90-day window. The ATO must exercise its discretion before a valid downsizer contribution can be made after the 90-day window.

What if you get it wrong?

If the ATO determine that a downsizer contribution has been made incorrectly, it can direct the receiving super fund to treat the contribution as if it was not a downsizer contribution. What this means in practice is the APRA fund must re-assess whether the fund was in a position to accept the contribution under Superannuation Industry Regulations 1994 (SIS) regulation 7.04, which contains the age-based restrictions on super contributions.

Essentially, the contribution now needs to be assessed as a personal contribution. If the individual was over 75 at the time the contribution was made, the fund will have 30 days from when notified by the ATO to refund the contribution. If the individual was under 75, the super fund will need to determine if they had met the work test or the criteria for the work test exemption, and only if neither of those conditions is met, is the contribution refunded.

One of the lesser-discussed changes as part of the 2017 ‘fair and sustainable’ super reforms was the removal of the fund-capped contribution restriction in SIS regulation 7.04. This required a super trustee to reject any single contribution that was in excess of the annual non-concessional contributions cap based on the member’s age.

If the fund-capped rule was still in place, this would have allowed super funds to refund the disallowed contribution in excess of the non-concessional contribution cap, reducing any excess contributions issues – but in its absence, funds are severely restricted from refunding amounts when the member has met the work test. As such, individuals under age 75 who are still working when they make a downsizer contribution, could inadvertently breach the non-concessional contributions cap simply because they did not submit the correct paperwork at the time of the original contribution.

In some cases, the super fund may not be in a position to refund the whole contribution due to fees, negative investment return or pension payments, for example. In this case, according to CRT Alert 039/2019, the ATO expects the super fund to re-report the amount of the contribution that cannot be returned as a non-concessional contribution. This can in turn create excess contribution issues based on money which may no longer be within the super environment.

It is worth keeping in mind that even an individual who is over the age of 75 has a non-concessional cap of $100,000 – despite the fact that SIS regulations are written in such a way that the individual cannot access this cap.

For example, an individual aged 80 makes a $300,000 downsizer contribution, which is subsequently treated as ineligible by the ATO. At the time the ATO advises the super fund of this, the member’s balance has reduced to $270,000. The fund returns the $270,000 to the individual, and then reports a non-concessional contribution of $30,000 covering the difference. Despite the fact the individual could not make a non-concessional contribution, the $30,000 will count towards their $100,000 cap. In this situation, no excess issues exist.

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QUESTIONS

For CPD quiz, click here.

1. What timeframe does an individual generally have to make a downsizer contribution?

a. 28 days after the end of the month in which the property settles.

b. 90 days from the change of ownership of the property.

c. 90 days from signing the contract of sale, or the date of receiving the proceeds.

d. Any time after the sale. There is no time limit.

2. Is it possible to make a downsizer contribution using vacant land?

a. Yes, there are no restrictions on having a dwelling on the property.

b. Yes, but only if the dwelling was destroyed by fire.

c. No, a dwelling is required to qualify.

d. Yes, but only if the ATO provides an exemption.

3. If a downsizer contribution is disallowed, what is the super fund initially required to do?

a. Immediately refund the contribution.

b. Determine whether they were able to otherwise accept the contribution under SIS regulation 7.04.

c. Treat the contribution as a non-concessional contribution.

d. Treat the contribution as a concessional contribution, taxing the contributed amount.

4. A retirement village will qualify as a dwelling for a downsizer contribution if:

a. There is a central management team who administer the village.

b. There are at least 50 residents in the village.

c. The dwellings are not mobile.

d. All of the above.

5. Does subdividing a property mean a downsizer contribution is no longer able to be made?

a. Yes, the subdivided properties are considered new assets and the 10-year ownership period resets.

b. No, any subdivided blocks will still qualify, as they came from the original block.

c. No, however, the block with the dwelling upon it must be sold to qualify – the other blocks sold individually do not qualify.

d. Yes, there is a permanent loss of the ability to make a downsizer contribution, as the venture is now potentially producing assessable income.