Capital Gains Tax – How to sidestep

Question

I am a member of the real estate owners group and have a copy of your bulletin "how to sidestep CGT" in relation to using main residence excemption to keep an investment property free of capital gains tax.

I am a little confused at the ruling that you have given. I have a rental property in Townsville that I have rented out since purchasing it in late 2003 which has more than double in value in that time. Are you saying that if at the time that I intend to sell it (which will be around August 2010 at this point in time) that if I move into it before I sell it I can claim it as my principle place of residence and pay no CGT whatsever as it will be my PPR. The other scenarios below may also have some ramifications on this? If I misunderstand your ruling, then could you please clarify how I am able to sidestep CGT on this property.

I currently reside in a property that I purchased as a rental but in fact never rented it out but moved into it myself. I am not claiming principal place of residence on any other property that I own. How will CGT affect me when if I sell this property.

If I sell this property, then my proposal is to move into another property that I purchased in August 2007 and have again rented out since purchase. Again, will there be any CGT ramifications on this property if this then becomes my PPR.

I have also just sold a vacant block of land that I purchased in February 2007 with the sole intention of building a rental home on, but due to the purchase of the other property in August 2007 was not able to proceed with building on it. I have paperwork to support my proposal to build due to my dealings with a home builder, paying deposit etc. Will the sale of this vacant land be subject to CGT with 50% discount or fall into the category of normal income. Is all of the interest that I paid on the loan for this property tax deductible.

Anything you could advise in relation to saving tax on my investments and/or the besy way to deal with these would be most appreciated.

Kind regards,
Marlene

Answer

The first thing you need to understand is that you have to first live in a property before it can be covered by your main residence exemption. Only once you have moved in can you start to access all these lovely concessions. So moving into a rental property will only mean that you can utilise these advantages from that day forward. With the exception of the 6 months over lap rule in section 118-140. Which, in strictly limited circumstances, allows you to cover both the property you re moving into as your main residence and the property you are moving out of for up to 6 months before your previous home is sold. There is also a 4 year backdate concession if you build or renovate a house but this on will not let you cover 2 properties.

If you have first used a property as a rental property for 5 years then used it as your main residence for another 5years then 50% of the gain will be taxable. The trick is that the 50% is not applied until after the gain is calculated. The cost base of the property will include all the normal things you would expect such as purchase price, buying and selling costs and any costs of ownership that have not otherwise been claimed as a tax deduction. This doesn’t mean much while it is rented as probably all the other costs are claimed as a tax deduction. But while you live there this means that your cost base can include the interest, rates, insurance, repairs and maintenance etc. Any cost of ownership so light globes, plants, cleaning materials etc can be added to the cost base. Reference Section110-25(4). The difference between all this and the selling price is the gain. But only 50% of this gain is taxable because it was only used as a rental for 50% of the time. See how the costs of while you were living there effectively reduce the gain for when you weren’t. Once you have halved the gain to represent the time it was rented you then deduct any capital losses you have and halve the amount again for the 50% CGT discount.

Moving onto your questions:

If you moved into the Townsville property for 2 years after owning it for 5 then 2/7ths of the gain would be exempt from CGT and you would get the opportunity to increase the cost base by some of your living costs.

You can completely exempt the property you currently live in from CGT by giving it your main residence exemption rather than any other place during the time you owned it. You do not have to decide whether to give it your main residence exemption or not until you sell it. If you move from this home when it is sold into the Townsville home you will be able to back date your main residence exemption on the Townsville property to 6 months before your current home was sold covering your current home at the same time. Even though there was a tenant in the Townsville house during that time.

If instead you move into the property you purchased in August, 2007 you can back date your main residence exemption as explained in the paragraph above and increase its cost base by all the costs associated by living there. With very careful record keeping you maybe able to completely eliminate the gain. The only catch is there is nothing you can do to get rid of the sleeping CGT problem. No matter how long you own it you will always have to keep records and work on the CGT, however small, when you sell. The only hope I can give you here is if this property is your main residence when you die your heirs will inherit it at market value without the sleeping CGT problem.

Re the vacant land both Steele’s case and the ATO rental property guide support your right to claim the interest on the land while ever you held it with the intention of building a rental property and as your intention was never resale at a gain you will be entitled to the 50% CGT discount if you have held the property for more than 12 months. The trick is convincing the ATO that was the case.


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