Capital Gains Tax — the second part of the question

Question

I bought a house 15 months ago. It is a corner block and I will be able to subdivide it. I paid $455K ex SDuty for it. The house is 815 sqm. The subdivision will leave me with the house being 500 sqm and the new land 315sq. The subdivision will cost around $30K when ready to build on.

3) If I decide to build a house on the land am I able to switch houses to claim the principle place of residence and avoid CGT? So I would rent out my current home and move into the new home for a few months. And then move back into the older home and rent out the newer home for just short of 6 years? And repeat the exercise until I decide to keep the new home and sell the old home. Or will I eventually need to pay CGT on one of the houses?? And does it matter if the houses are next door to each other. Can I still negatively gear the new property?




regards Therese

Answer

Please read through this twice before you throw your hands up. I think it makes much more sense when you know what I am getting to at the end.

As you will see in the How not to be a developer booklet even the CGT main residence exemption cannot apply if you are considered to be in business ie bought the property with the intention of splitting it and selling it. Though if it was only your intention to sell one half the other half could have your main residence exemption.
You need to be more along the lines of buying the property to live in and then changing your mind, may be wanting a bigger house. The longer the period between purchase and subdivision the better.
With the exception of a 6 months overlap rule that can only apply in very limited circumstances you cannot cover more than one property with your main residence exemption at a time. So if you use it on one property the other property will be exposed during that time. Further, you have to live in the house at least once to even qualify. Even if the land to date has been covered by your main residence exemption, once it is cut off from the house and land and sold separately it loses the main residence exemption for the period it was attached to the house.
There is also the risk of GST applying to the new house or vacant land if you are considered to be in business and there is no doubt that deciding to build a house to promptly sell is a business.
You can negatively gear either property while they are earning income, including claiming depreciation this is the case even if it is also being covered by your main residence exemption during your absence ie living next door.
GST – Unlike vacant land the strategy of building a new house and renting it is superior in helping you avoid having to pay GST on the sale of the new house for any of the following reasons.
1) You built it as a rental and you are not already registered for GST so you are not required to do so just because you choose to sell a
property you built with the intention of holding as a rental. Section 23-5 states that if the annual turnover of supplies you make in the normal course of your enterprise, exceed $75,000 you must register for GST. Section 185-25 excludes from the calculation of annual turnover the supply of a capital asset. Building the property for rental then selling, is the supply of a capital asset and not included in the annual turnover. Section 118-15 excludes from annual turnover input taxed supplies so any domestic rent received is not included in annual turnover. The trouble is if you sell too soon it is hard to argue you didn’t build it to sell. You need another reason for changing your mind.

2) The house has been held as a rental for a continuous period of more than 5 years.
Fortunately you do not have to choose which property to give your main residence exemption to until you sell one. If you work this well and keep your options open then you can just choose the one that gives you the highest capital gain.

Here is an example of the tax effect of what I think you are trying to say.

In order to cover your old house all the time with your main residence exemption but keep your options open to switch to the new house, it would work like this:
You live in the old house and have done so since settlement as your main residence. When you move into the new house and rent out the old the cost base of the old house is reset to the market value at that date (section 118-192). You live in the new house for less than 6 years then move back into the old house for a while back and forth each 6 years to utilise section 118-145 and fully cover it with your main residence exemption,

Note 118-192 (reset cost base) will not apply if you decide to use 118-150 (back date main residence exemption up to 4 years) on the new house but again you don’t need to make this choice until you sell one.

In order to cover your new house all the time with your main residence exemption but keep your option open on the old house:
AS long as the period between buying the property and moving into the new house is less than 4 years and you move into the new house as soon as it is completed and live there for at least 3 months then section 118-150 will allow you to cover it with your main residence exemption back to the date you first bought the land underneath it. Of course you can’t cover the old house at all. You can then proceed to play the 6 year game under section 118-145. Note that section 118-192 will automatically reset the cost base to market value the first time you rent it out, should you decide to utilise section 118-150 something to consider if you over capitalise but this could work well if you use the rates notice unimproved valuation to apportion the cost base of the land so that the old house receives a high cost base.

Tip:
Good record keeping will save you heaps. Odds are that the house you live in the most will have the lowest capital gain. Section 110-25(4) allows you to increase the cost base by any costs associated with the property that have not otherwise been claimed as a tax deduction. This includes interest, insurance, rates, repairs and maintenance even light globes, lawn mower fuel, cleaning materials etc. Naturally it will be the one you are living in where these items are not claimed as a tax deduction.
Note section 118-192 will reset the cost base to market value of any house that has been fully covered by your main residence exemption up to the time you first rent it out.
The only issue I see with them being next door to each other is the ATO trying to argue you moving back and forward is just a scam for tax purposes.
Fortunately you do not have to decide until you sell one but you have to keep very good records to make the most of your options. A little bit of crystal ball gazing would help in deciding which one should be the rental most of the time though you may have a personal preference anyway, after all that should be more important that tax benefits.

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