Distributing Discounted Capital Gains to Trust Beneficiaries

Question

I have several questions regarding how Capital Gains Tax would apply to a transfer of title of a residential property to one of my children.

Background: In 1981, I purchased a residential property in Sydney and I was registered as the sole proprietor. From the date of purchase, my wife and I occupied the property as our home.

In 1998, title to the property was changed whereby both my wife and I became registered on the title as joint tenants.
In 2008, the property ceased to be our home (ie. principal place of residence) as my wife and I moved away from Sydney to Terrigal on the NSW Central Coast where we purchased a house and have lived there from 2008 to date.

Since 2008 to date, one or both of our two children have lived in the Sydney property (ie. our former home), rent-free.

My wife and I are considering transferring title to the Sydney property out of our names and into the name of our son so that our son would become registered on the title as the sole proprietor.
Several questions arise in considering the CGT position.

Q1. As I acquired the Sydney property prior to the introduction of CGT in 1985, am I right in thinking that my share or interest in the property is to be disregarded?

Q2. If the answer to Q1 is yes, am I correct in concluding that my wife’s share or interest in the property is half and that it is her half share that would be subject to CGT?

Q3. When my wife became a joint tenant on the title in 1998, did that trigger a CGT event so that a valuation of the property would be required to establish the cost base and that only half the value of the valuation would form the cost base for my wife’s CGT liability?

Q4. If 1998 is the cost base, can expenses incurred in improving and repairing the property be added to the cost base up to 2020? Also, can Council rates and building & contents insurance premiums be added to the cost base? Or is it the case that these expenses can only be added to the cost base from 2008 onwards given that from 1998 to 2008, the property was our principal place of residence? Finally, I don’t have records for all expenses, etc incurred – can they be estimated or must actual receipts be held?

Q5. If the answer to Q3 is that 1998 did not trigger a CGT event, is it the case that 2008 is the relevant trigger event on the basis that up to 2008, the property was our principal place of residence and so is exempt from CGT until 2008?

Q6. If 2008 is the cost base, can we add the expenses referred to in Q4 to the 2008 cost base (for which a valuation would be required) with only half the value to be used for calculating my wife’s CGT liability?

Q7. If, as I suspect, the CGT liability extends from 1998 to 2020 which is a period of 22 years, can I presume that because the property was our principal place of residence from 1998 to 2008 (10 years), 10/22 of any capital gain is tax-free?

Q8. Whatever the capital gain is arising from the above facts, are the following two discounts to be applied: (a) Only 50% of the gain is recognised because my half share is to be disregarded – refer Q1; and (b) A further 50% of the resultant capital gain is applied given that the property has been our home for over 12 months? And I presume that this discount would only apply if the cost base year is 1998.

The following worked example may assist in applying the relevant CGT principles. The example below assumes that 1998 is the cost base year.

1. Value of property in 1998 – say, $400k
2. Cost of improvements, etc from 1998 to 2020 or from 2008 to 2020? – say $100k
3. Cost base = $500k
4. Value of property in 2020 – say $2.2m
5. Capital gain = $1.7m
6. Half the capital gain of $1.7m is disregarded given my interest in the property arose before 1985. Therefore, the resultant gain is now $850k
7. A further reduction is made as the property was the principal place of residence for 10 years. Therefore, 10/22 of $850k results in a reduction of $386,364k, producing a capital gain of $473,676.
8. Half of the gain of $473,636 is made because the property was our home for over 12 months. This results in a taxable gain of $236,818.
9. The taxable gain of $236,818 is added to my wife’s taxable income in the year in which the CGT liability arises.

Q.Have I applied the correct principles and have I applied them in the correct order to arrive at the final taxable capital gain?


Answer

A couple are only allowed one main residence exemption between them but they can apply their half to different homes. You need to treat the old home as two separate assets. Half owned by you since 1981 and the post CGT half-owned by your wife. In 2008 when you purchased the new property you had nothing to lose by transferring your half main residence exemption to it because your half of the old property was protected as pre-1985. The answer to your question regarding your half of the old home is simple, no CGT can apply. Your wife, on the other hand, needs to decide where she wants to put her main residence exemption from 2008 onwards. She has the choice of either property.

The important piece of legislation for you is section 118-145 ITAA 1997 which allows you to cover your old home with your main residence exemption indefinitely as long as it is not earning income and you do not cover another property with your main residence exemption during that time. It is a choice, not a question of where you live. The choice to cover the old home with your wife’s half main residence exemption will save you CGT now (if you do end up transferring to your children) and may not ever cost you CGT on the other property if it is still your main residence when you die. You see your heirs inherit the property covered by your main residence exemption when you die at market value at date of death so all possible CGT that could apply if you sold in your life time is forgotten and forgiven. I assume your current home is joint tenants. The transfer between joint tenants when one dies does not get the reset to market value but does not trigger CGT either. When the surviving spouse dies then the cost base is reset to market value for the heirs. Of course, providing that it is the surviving spouse’s main residence at DOD. Now they don’t actually have to be living there, they can be in a nursing home, just as long as it is still technically covered by their mains residence exemption, for example by the 6-year absence rule if rented out.

Now because your old home has never been used to produce income, there has never been a reset to market value. This means that any CGT calculation is pro-rata between days covered by your main residence exemption and days not. It is up to you how many days are not. Bird in the hand approach is what I usually see. If your wife chooses to continue to cover the old home with her main residence exemption from 1998 to when sold then no CGT on the sale at all.

Q1 Yes

Q2 She has a choice

Q3 You wife’s cost base is half the value of the property in 1998

Q4 From 1998 need a record of expenses, which can include bank statements, though I have known the ATO to be lenient with estimates

Q5 No CGT event in 2008 at all not even a reset

Q6 No valuation needed as no reset because did not produce income

Q7 Basically correct but can be exempt for 22 of the 22 years if you choose and it is certainly exempt for 22 of the 22 years for you

Q8 Two separate assets CGT only has the potential to apply to your wife’s share and she is entitled to the 50% CGT discount then, of course, apportion the gain for number of days covered by main residence exemption.

If you decide you do want to expose the old house to CGT you might like to rework your numbers with the above information in mind and ask another question, to confirm you fully understand.

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