Ask Ban Tacs Question
My wife and I currently own and live in a house in the town of Cervantes. This is our principle residence and understand that no CGT will be applicable when we sell it. We will then shift into our home unit.
My wife and I purchased the home unit in April 2005, for $440,000. It was rented out on a commercial basis until March 2011. We paid off the mortgage in June 2016. We have used the unit as a residence when we visit Perth. Not our principle residence.
We will eventually sell the unit. Estimated sale price of $800,000 and purchase a house to live in. What can be claimed to increase the cost base?
We understand that we will have to pay some CGT.
Answer
Yes, your home at Cervantes should not be subject to CGT if it has always been your home and you moved in there promptly after purchase. With the exception of the 6 months overlap you can only cover 1 property with your main residence exemption so the Perth unit is your CGT problem.
The 6 months overlap, section 118-140 ITAA 1997 allows you to cover two properties dating back 6 months just before you sell the Cervantes house providing that is not being used to produce income. It does not matter that the Perth unit maybe being used to produce income during that 6 months. Though I am going to assume now that the Perth property will not produce income, that stopped in 2011.
Now to the capital gain on the Perth unit. There is no resetting of the cost base when you move in, it will be a pro rata calculation between days covered by your main residence exemption (probably 6 months before you sell Cervantes) and days not covered by your main residence exemption. I attach a spreadsheet that explains what records you need to keep and helps you keep them in a constructive way. There is also a CGT estimator there but that will become out of date if the CGT changes get through Parliament. The most valuable tax tip here is good record keeping.
You start with the original purchase price, stamp duty, legal fees and any other cost to buy. Section 110-25(4) ITAA 1997 is where the money is. This section allows you to increase the cost base by any holding costs that you have not otherwise claimed as a tax deduction. Holding costs include rates, interest, land tax, body corporate, insurance, repairs and maintenance. You have probably claimed most of these as a tax deduction while it was rented but after 2011 there should be a lot to add in. This includes the time that you live there as your main residence and maintenance even includes cleaning materials. If, during the time it was a rental, you were claiming Div 43 building depreciation you will have to decrease your cost base by this amount.
The way the formula works is you first calculate the capital gain then apportion it between days covered by your main residence exemption and days not so effectively the costs associated with the property while it is covered by your main residence exemption can proportionally reduce the capital gain on the days it ways not covered.
Example
| Purchase Price Less P&E | $435,000 |
| Purchase costs | $10,000 |
| Holding costs not otherwise claimed | $50,000 |
| Selling costs | $15,000 |
| $510,000 | |
| Reduce by Div 43 deprn claimed | $30,000 |
| Cost base | $480,000 |
| Less Selling Price | $800,000 |
| Capital Gain | $320,000 |
| Less 50% CGT Discount | $160,000 |
| Taxable Gain | $160,000 |
Possibly split between owners.
Notice how the plant and equipment value has been removed from the purchase price. This is based on the assumption that you originally claimed depreciation on things like the stove, carpet, air conditioner, dishwasher and hot water service. If you did not there is no need to reduce the purchase price. The selling price should also be reduced by the value of any of that original plant and equipment that remains or any you purchased while it was a rental that remains when you sell. Though by that time I expect it will be very little as there is no need to do anything if the plant and equipment has not been claimed as a tax deduction which is the case from 2011as the unit was held for private purposes.
Now what happens if you sell after 1st July 2027? Well if the legislation goes through as it was presented to parliament last week then the gain you make up to 1st July 2027 is locked in. It is not taxed until you actually sell the unit. It is referred to as a deferred capital gain and that is all that will be entitled to the 50% discount. Note there is some fancy footwork in the legislation that makes sure it is this pre 2027 gain that is first reduced by any capital losses you have carried forward up to the financial year of sale and any capital losses in the year of sale. This happens before applying the 50% discount. The formula ensures that that any reduction to capital gains in the year of sale comes off the portion subject to the 50% CGT discount first.
If you move into the unit before 1-7-2027 or the legislation does not go through then the $320,000 above is reduced by the percentage of time it is covered by your main residence exemption. Let’s say you move into the unit 1-1-2027 then you have 6 months living there and the 6 months overlap rule. Giving you a full year covered by your main residence exemption up to 1-7-2027. Now the apportionment must be on a number of days basis but for simplicity of the example let’s assume you purchased the unit in July 2005 instead of April. So out of 22 years ownership 1 was covered with your main residence exemption. One 22nd of the $320,000 is removed from the gain bring it down to $305,454 then you apply the 50% discount, making the taxable gain $152,727. The actual rate of tax will depend on your personal tax rates.
The example above continues on if the law does not change. So for the longer you live there the bigger percentage of the gain that will be removed before the discount is applied.
If the legislation comes through as presented and you are living there on 1-7-2027 and continue to cover it cover it with your main residence exemption up till you sell it then no further CGT calculation you just put in the deferred gain calculated up to 1-7-2027.
Note there is an option in the legislation to not draw that line in the sand with the market value at 1-7-2027 but to pro rata the gain over the whole period of ownership and then apply the discount to the percentage of ownership days that were before 1-7-2027. It is expected that this will not provide the best outcome considering the capital growth we have experienced and the intention of this legislation to bring down property prices.
So now let’s look at the situation where you didn’t move into the Perth unit until after 1-7-2027 and you have elected to use the market value method for the 1-7-2027 changes. So the calculation up to that date would be along these lines:
Example
| Purchase Price Less P&E | $435,000 |
| Purchase costs | $10,000 |
| Holding costs not otherwise claimed | $50,000 |
| $495,000 | |
| Reduce by Div 43 deprn claimed | $30,000 |
| Cost base | $465,000 |
| Value at 1-7-2027 | $830,000 |
| Capital Gain | $365,000 |
| Less 50% CGT Discount | $182,500 |
| Taxable Gain | $182,500 |
After 1-7-2027 you start with:
| Market value of | $830,000 |
| This can be indexed but holding costs cannot | |
| So let’s say by the time you sell indexing adds | $20,000 |
| Then actual holding costs since 1-7-2027 | $30,000 |
| Selling Costs | $15,000 |
| Cost base | $895,000 |
| Less Selling Price | $945,000 |
| Capital Gain | $ 50,000 |
Note no Div 43 Depreciation write back because
Not ever rented again after 2011
Let’s say 80% of the time from 1-7-2027
It was covered by your main residence exemption
So only $10,000 if thus $50,000 capital gain is taxable bringing the total taxable capital gain to $192,500 but that $10,000 post 1-7-2027 amount
Will be subject to a minimum tax rate of 30%.
Note if the post 1-7-2027 portion was actually a loss then that would reduce the pre 1-7-2027 capital gain before applying the 50% CGT discount.
Clear as mud? I hope not, please feel free to ask for clarification
Please note this answer is limited by the information you have provided and should not be relied upon without further professional advice on your particular circumstances.
