There are circumstances where individuals may not be eligible for a full CGT exemption on the sale of their home.

Financial planners regularly find themselves having to consider the complicated tax consequences of changes to people’s residential arrangements and the impact on the advice.

Under the Income Tax Assessment Act 1997, subdivision 118-B, a dwelling (and land of up to two hectares) used solely as a main residence and not used to produce assessable income will be exempt from capital gains tax (CGT) on sale by an individual taxpayer who is an Australian tax resident.

The legislation does not define what makes a property your main residence. The Australian Taxation Office (ATO) considers a number of factors and individual circumstances, including:

• whether the individual and their family live in the property and for how long;
• keeping of personal belongings in the property and having services, such as gas and electricity connected; and
• the address on the electoral roll and mail delivery.

For tax purposes, a dwelling is considered a main residence from the time the individual acquires their ownership interest, provided they move in as soon as practicable. For property purchases, this is generally the contract settlement date. If there is a delay in moving in due to unforeseen circumstances, the exemption can still apply, provided the taxpayer moves into the property as soon as the delay ceases. Unforeseen circumstances could include unexpected illness or an unavoidable overseas trip.

However, being unable to move in due to the property still being rented to someone else would generally not fall within this exemption. In this case, the exemption would not apply from the commencement of ownership.

Example 1: Albie purchased an apartment in January 2018, and settlement took place in April 2018. In February 2018, Albie was directed by his employer to work overseas in their Singapore office for six months. He therefore didn’t move into his new apartment until August 2018. As Albie’s overseas employment was not known at the time of purchase, the ATO could choose to treat his action as ‘moving as soon as practicable’. In this case, he may be allowed to treat the apartment as his main residence from the date of acquisition.

With a full CGT exemption, the individual does not pay any tax on any capital gain from the future sale of the property. However, any capital loss cannot be used to reduce assessable income.

There are circumstances where individuals may not be eligible for a full CGT exemption on the sale of their home and a number of these will be explored in this article.

Using part of the home to generate income

Unless the dwelling was acquired before 20 September 1985 and falls under the pre-CGT rules, if an individual uses part of their home at any point in time to generate income, the full CGT exemption may not be available upon future sale.

The test for whether a home is used to produce income is known as the ‘interest deductibility’ test. The individual needs to ask: ‘If I had borrowed money to purchase the dwelling, would I be allowed any deduction for interest costs due to the income producing activity?  If the answer is ‘yes’, then a full CGT exemption may not apply. The most common examples are:

• renting out part of the home; and
• running a business using part of the dwelling.

However, if an individual rented part of their home to a family member who rather than pay rent, either paid board or contributed to household expenses, then the full main residence exemption may still apply.

How the CGT exemption is calculated depends on:

• whether the property was used initially as a main residence; and
• whether the dwelling was first used to produce income after 20 August 1996. The ‘home first used to produce income’ rule is discussed in the next section.

If the property was used to produce income before becoming the individual’s main residence – for example, it was initially rented out – a portion of the capital gain on sale is subject to CGT and the cost base will be based on the initial purchase price.

When an individual can only claim a partial main residence exemption, the proportion of the capital gain that is assessable is generally determined by the amount of floor area of the home used to generate income and the time period over which the ‘income producing activity’ took place.

The ‘home first used to produce income’ rule

The CGT rules changed at 20 August 1996 and the calculation rules differ depending on whether the house was first used for income producing purposes before or after this date.

The rules are:

• The property ceased being used as the main residence and was first used to produce income on or before 20 August 1996 – cost base is the original purchase price.
• The property ceased being used as the main residence and was first used to produce income after 20 August 1996 – the individual is taken to have acquired the property at its market value at the time first used to generate income. Note that the individual must have been entitled to a full exemption had they sold their home immediately before first using it to produce income.

Example 2: Shannon bought a house in 2010 for $500,000 and in July 2014 began running an IT business from home, using her study (10 per cent of the floor space). The market value at the time she commenced her business was $700,000. She sold the property in 2017 for $1,000,000. With the assistance of her accountant, she estimates her capital gain as:

= ($1,000,000 – $700,000) x 10 per cent = $30,000

Note: 50 per cent of the gain is exempt, as she held the property for more than 12 months.

Changing main residences

A taxpayer cannot have two main residences at the same time for CGT exemption purposes. However, there is a special rule when a person acquires a new home before selling the old one that allows them to treat both residences as their main residence for the period between acquiring the new residence and disposing of the existing home for up to six months.

To qualify, the individual must have lived in their former home for a continuous period of at least three months in the 12 months prior to disposal. During these 12 months, the dwelling cannot have been used to generate assessable income.

Provided the former home is sold within six months of purchasing the new home, both can be exempt from CGT during the overlap period. If the former home is not sold within six months, both properties will only be eligible for the exemption for six months, meaning one of the dwellings will only receive a partial CGT exemption on sale.

Example 3: Troy and Lexie bought a new home, with settlement on 1 July 2016, and they moved in immediately. They sold their existing home later that year, with settlement on 1 March 2017.

Option 1 – Partial exemption for the old home

Both homes are treated as their main residence for the last six months that Troy and Lexie owned their old home from 1 September 2016 to 1 March 2017. Therefore, their old home is treated as a main residence for CGT for the time before settlement of the new home (i.e. pre 1 July 2016) and during the last six months before settlement of the sale. The 62 days from 1 July 2016 to 31 August 2016 when their old home is not their main residence are used to calculate the proportional assessable capital gain on sale.

Option 2 – Partial exemption for the new home

If they choose to treat their old home as their main residence until settlement of sale at 1 March 2017, their new home will not qualify for a full CGT exemption on sale. Their new home won’t be considered their main residence for CGT purposes during the 62 days from 1 July 2016 to 31 August 2016.

Moving out and the six-year rule

Generally, upon moving out of a home, the dwelling will cease to be an individual’s main residence. However, if a taxpayer moves out of their main residence, they can continue to treat the property as their main residence for CGT purposes, provided they don’t treat another property as their main residence (except for the limited six-month period if moving between homes). The exemption can apply:

• indefinitely if the home is not used to produce assessable income; or
• for up to six years if the home is rented. The maximum six-year period is reset if the taxpayer moves back in.

Example 4: Dano bought a home in Melbourne in August 2008 and moved in immediately. In September 2014, he relocated to Hong Kong for a two-year work assignment and rented out his Melbourne house. He returned to his Melbourne home in September 2016 and lived there again for one year. In September 2017, Dano moved to Sydney and again rented out his Melbourne home. In January 2019, he purchased a new main residence in Sydney and sold his Melbourne property in March 2019.

When he completes his tax return for the 2018-19 financial year, Dano may be able to treat the Melbourne property as his main residence during both absences, as the period used to produce income is less than six years. His accountant advises he can either:

• elect to treat the Melbourne property as his main residence until March 2019, therefore getting a full CGT exemption. He would not receive a full CGT exemption on sale of the Sydney property; or
• choose to treat the Melbourne property as his main residence until January 2019, and therefore not receive a full CGT exemption.

If the property is rented out for more than six years, the ‘home first used to produce income’ rule may apply. That is, the individual has acquired the dwelling at its market value at the start of the six-year period. However, CGT will not apply until either the end of the six-year period or point of sale, whichever date is earlier.

Using any part of the property to produce income prior to moving out means the individual cannot apply ‘the continuing main residence’ exemption.

Vacant land

Building a house on land you already own will usually only qualify for CGT exemption once the dwelling becomes a main residence.

The exception to this is if an individual purchases a block of land and builds a dwelling on it within four years and occupy it as their main residence for at least three months. In this case, the land can be treated as the person’s main residence back from the initial land purchase, providing all eligibility criteria are satisfied.

Foreign residents

In the 2017–18 Budget, the Government announced that foreign residents will no longer be entitled to claim the main residence exemption when they sell property in Australia. This change is not yet law and lapsed with the 2019 election.

Legislation has been reintroduced to parliament in October 2019 and if passed, a foreign resident at the time of selling their home in Australia may not be entitled to claim the main residence exemption.

Inherited dwellings

When an individual inherits a house, whether CGT will apply on the sale depends on the timing of when the deceased purchased the home and the date of their death.

Deceased acquired dwelling before 20 September 1985 and died on or after 20 September 1985

CGT does not apply:

• if the beneficiary or estate sells the dwelling within 24 months of death (unless an extension is granted); or
• from the date of death until disposal of ownership, the dwelling is treated as the main residence of the beneficiary, the surviving spouse or an individual with a right to occupy the premises under the deceased’s Will.

Deceased acquired dwelling on or after 20 September 1985 and passes to beneficiary on or before 20 August 1996

CGT does not apply:

• if the deceased used the dwelling as their main residence for the entirety of their ownership period; and
• from the date of death until disposal of ownership, the dwelling is treated as the main residence of the beneficiary, the surviving spouse or an individual with a right to occupy the premises under the deceased’s Will.

Deceased acquired dwelling on or after 20 September 1985 and passes to beneficiary after 20 August 1996

CGT does not apply if:

• Immediately prior to death, it was the deceased’s main residence and either:
  • the beneficiary or estate sells the dwelling within 24 months of death (unless an extension is granted); or
  • from the date of death until disposal of ownership, the dwelling is treated as the main residence of the beneficiary, the surviving spouse or an individual with a right to occupy the premises under the deceased’s Will.

A partial capital gain or loss is calculated based on the ‘non main residence days’ as a proportion of total days. The cost base would be the market value at the date of death if:

• the deceased acquired the residence before 20 September 1985; or
• the deceased acquired the residence on or after 20 September 1985, it was their main residence immediately preceding death and it passed to the beneficiary after 20 August 1996.

Naturally, financial planners assisting clients on these matters should always advise the client to seek tax advice from their accountant.

Brooke Logan, Advice Technical Consultant, UniSuper Management.

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QUESTIONS

To answer the CPD questions, click here.

1. Which of the following would the ATO not consider when determining if a property is a taxpayer’s main residence?

a. How long the taxpayer has lived in the dwelling.

b. Keeping of personal belongings in the property.

c. Having services, such as gas and electricity connected.

d. The acquisition cost of the property

 

2. Nick purchased a home in Brisbane in April 2010 and moved in immediately. In January 2014, he moved in with his girlfriend and rented out his Brisbane property. He sold the Brisbane property in January 2019. Which statement is correct?

a. Nick may be able to claim a full CGT main residence exemption on the Brisbane property, as the income producing period was less than six years.

b. Nick may be able to claim a partial CGT main residence exemption on the Brisbane property. He is taken to have acquired the dwelling at its market value at the time first used to produce income (January 2014).

c. Nick may be able to claim a partial CGT main residence exemption on the Brisbane property. The cost base will be based on the original purchase price.

d. Nick may be able to claim a full CGT main residence exemption on the Brisbane property, as the income producing period was less than 10 years.

 

3. Cherie bought a property in August 2008 and sold it in August 2018. It was her main residence for the entire period. During this time, she rented a room to Archie. Her accountant advises Cherie would be entitled to a 20 per cent deduction for interest (if she had incurred it) on money borrowed to acquire the home. Cherie made a capital gain of $500,000. What is the estimated assessable capital gain before applying the 50 per cent  discount?

a. $0.

b.$50,000.

c.$500,000.

d.$100,000.

 

4. Lucy purchased a home in 1990 and died in July 2000, at which point the property passed to her son, Wilbur. It was Lucy’s principal residence immediately preceding death. Wilbur lived in the property until January 2009 and then rented it out. Which statement is correct if Wilbur now sells the property?

a. There will be a partial capital gain and the cost base will be based on the market value at Lucy’s death.

b. There is a full CGT main residence exemption, as Wilbur lived in the property for more than six years.

c. There will be a partial capital gain and the cost base will be based on the market value when Wilbur first rented out the property.

d. None of the above.

 

5. Zed purchased a block of land in November 2018 and intends to build his home on it. Which of the following must be satisfied for Zed to be able to treat the land as his main residence from the initial land purchase date?

a. He must build his home within four years of purchasing the land and then occupy it as his main residence for at least three months.

b. He must build his home within three years of purchasing the land and then occupy it as his main residence for at least six months.

c. He must build his home within six years of purchasing the land and then occupy it as his main residence for at least three months.

d. He must build his home within four years of purchasing the land and then occupy it as his main residence for at least six months.