Main residence exemption – rent not derived – ownership interests apportionment

Question

Dear Julia,

My husband and I are moving back to Australia in February 2012, when my current 3 year overseas work posting concludes. We have both remained Australian residents for tax purposes. My work involves an expectation of ‘regular’ postings throughout my career (for approximately 3 years out of every 6). My husband expects to find professional employment in whatever country we happen to find ourselves in future (which would presumably not be taxable income in Australia as it would be of the nature of wages/salary for work performed in another country).

We are in the process of buying our first home (in Canberra). We hadn’t planned to buy a house until closer to our arrival on Australian shores, but I couldn’t resist this particular property, which is perfect for our family. We will be Tenants in Common (while we are borrowing jointly, I will own 99% of the property, my husband the other 1%, mostly in order to protect our home from potential liabilities associated with his possible future professional/business activities). We have just exchanged (conditional) contracts (subject to finance) and expect settlement/completion to occur in the next 6 weeks.

Our intention is to move into the house immediately upon conclusion of my overseas posting (i.e., in around 5 months from now, or about 4 months from settlement). Because of my current posting, it is not possible for us to move into the house before then. We think that our return to Australia is thus the “first practicable” moment at which we can move into our new home (s 118-135 refers). While we will have the utilities immediately connected in our names, we would prefer not to leave the house empty for the next several months (for both security purposes and as we could arguably deduct substantial costs like [A.C.T.] stamp duty and loan interest costs in the event that the house were rented for the 4-5 months until our return to Australia). We have read the strangely worded AAT decision about taxpayers in a somewhat similar situation to ourselves being denied the relief offered by s 118-135 but note that decision may have relied on “rent being derived” to disqualify the taxpayers for exemption under s 118-135 (Caller & Anor v FC of T refers).

We expect to travel abroad for my work postings again in future, at which time we would probably rent out the house and expect to rely on ‘the 6 year rule’ (s 118-145 refers). Given that we intend for this property to be our principal place of/main residence for at least the next 20 years, and could find ourselves renting it out for up to half of that period (i.e., by relying on consecutive applications of ‘the 6 year rule’), we don’t want to jeopardise our main residence CGT exemption (nor create an onerous requirement to keep records of holding costs associated with the property for the next 20+ years to apply to a CGT cost base in the event of only having a partial CGT exemption).

My questions then are:

1. If we advertised our new home for rent for the 4-month period immediately after settlement until our return to Australia (at which time we move into our home), could we still rely on the protection/exemption available under s 118 135 and 118-145 (and simultaneously claim relevant deductions for the 4 month period) if:
a. the house did in fact rent for that period (i.e., and rent was actually derived)?
b. The house did not rent for that period, for example if no suitable tenants could be found (i.e., and no rent was actually derived)?
2. If the answer to either or both of 1a. or 1b. is in the affirmative, could we deduct the entirety of the stamp duty in the current (2011-12) financial year (noting that it is a stamp duty on a lease as the property is in the A.C.T., but that the property would only be available to rent for a maximum of 4 months, not the entire year)?
3. In addition to having the utilities connected in our names, would there be any benefit in having our furniture and belongings removed from storage and delivered into the house immediately after settlement? (i.e., and offering our home for rent as a short-term, furnished rental, inclusive of utilities).
4. Will our decision to hold the property as Tenants in Common, with 99% of the ownership interest held by me and 1 % held by my husband, allow us to apportion revenues and deductions on the property when it is rented (in the short-term and during future postings) in those same proportions?
5. Noting that we will deal with the treatment of our ownership shares in the property via our wills, are there any other taxation benefits or pitfalls to this proposed ‘99/1 approach’ of which we ought to be aware?


Answer

You seem to be quite interested in the detail so I have included sections of the legislation I am talking about. As you can see the absence rule is intended to cover exactly your work situation in fact the example appears as if it is written for you. The trouble is of course (1) the bit about the “dwelling that was your main residence”



PART 3-1 – CAPITAL GAINS AND LOSSES: GENERAL TOPICS
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Division 118 – Exemptions
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Subdivision 118-B – Main residence
Rules that may extend the exemption
SECTION 118-145 Absences ITAA 36

118-145(1)
If a *dwelling that was your main residence ceases to be your main residence, you may choose to continue to treat it as your main residence.
118-145(2)
If you use the part of the *dwelling that was your main residence for the *purpose of producing assessable income, the maximum period that you can treat it as your main residence under this section while you use it for that purpose is 6 years. You are entitled to another maximum period of 6 years each time the dwelling again becomes and ceases to be your main residence.
118-145(3)
If you do not use the *dwelling for that purpose, you can treat it as your main residence under this section indefinitely.
118-145(3A) View history reference

This section does not apply if the *dwelling was your main residence because of section 118-147 and ceases to be your main residence because of subsections 118-147(3) and (4).
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118-145(4)
If you make the choice, you cannot treat any other *dwelling as your main residence while you apply this section, except if section 118-140 (about changing main residences) applies.
Example:
You live in a house for 3 years. You are posted overseas for 5 years and you rent it out during your absence. On your return you move back into it for 2 years. You are then posted overseas again for 4 years (again renting it out), at the end of which you sell the house.
You have not treated any other dwelling as your main residence during your absences.
You may choose to continue to treat the house as your main residence during both absences because each absence is less than 6 years.
You can make this choice when preparing your income tax return for the income year in which you sold the house.
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So now to section 118-135. I must admit I used to think that this was pretty straight forward and the soon as practical bit was necessary because the CGT event actually happens when you sign the agreement to purchase but obviously you can’t move in then. The practicable bit I thought simply referred to the fact that settlement will probably be required before you move in. Obviously from the arguments put before the court there can be more to it than that.
SECTION 118-135
118-135 Moving into a dwelling [No equivalent]

If a *dwelling becomes your main residence by the time it was first practicable for you to move into it after you *acquired your *ownership interest in it, the dwelling is treated as your main residence from when you acquired the interest until it actually became your main residence.



I agree that from Caller and other cases renting the property out will be the death of your argument that you moved in as soon as practical. But also consider Summer’s case (2008 AATA 152), the court found that even though the shed was not a traditional home she could cover it with her main residence exemption but only once she moved into it because she had not moved in as soon as practical after the shed was constructed. So not renting it out before moving in is not going to automatically give you the exemption.
You could apply to the ATO for a ruling on whether it is practical for you to move in while working overseas but I would rather see you try to qualify under other sections. Consider the following:
1) Moving your spouse into the property as soon as practical. It only has to be the home of one member of the couple to qualify, regardless of the percentage of ownership.
2) Utilise the 6 months overlap rule. The problem here is you must own another property, the 6 months overlap applies backwards from the date you sell the other property. So for example you could sell your home overseas just as you arrive back in Australia and section 118-140 would allow you to cover both properties with your main residence exemption for the 6 months before the sale which should give you a month to spare. The requirement is that the property being sold cannot be used as a rental but the new home can.
SECTION 118-140 Changing main residences ITAA 36

118-140(1)
If you *acquire an *ownership interest in a *dwelling that is to become your main residence and you still have your ownership interest in your existing main residence, both dwellings are treated as your main residence for the shorter of:

(a) 6 months ending when your ownership interest in your existing main residence ends; or

(b) the period between the acquisition of the new ownership interest and the time when the ownership interest referred to in paragraph (a) ends.
118-140(2)
Subsection (1) only applies if:

(a) your existing main residence was your main residence for a continuous period of at least 3 months in the 12 months ending when your ownership interest in it ends; and

(b) your existing main residence was not used for the *purpose of producing assessable income in any part of that 12 month period when it was not your main residence.



Or
3) Consider utilizing section 118-150. This would require the property to remain vacant while it is renovated and then you move into it as soon as practical after the renovations are completed.
SECTION 118-150 If you build, repair or renovate a dwelling ITAA 36

118-150(1)
This section applies to land in which you have an *ownership interest (except a life interest) if you build a *dwelling on the land, or repair, renovate or finish building a dwelling on the land.
118-150(2)
You can choose to apply this Subdivision as if the *dwelling that you are building, repairing or renovating on the land were your main residence from the time you *acquired the *ownership interest.
118-150(3)
You can make the choice only if:

(a) a *dwelling on the land that you construct, repair or renovate becomes your main residence (except because of section 118-147) as soon as practicable after the work is finished; and View history reference


(b) it continues to be your main residence for at least 3 months.
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118-150(4)
There is a time limit during which the choice can operate. This is the shorter of:

(a) 4 years before the *dwelling becomes your main residence; or View history reference


(b) the period starting when you *acquired your *ownership interest in the land and ending when the dwelling becomes your main residence.
118-150(5)
If there was already a *dwelling on the land when you *acquired your *ownership interest and you or someone else occupied it after that time, the period in subsection (2) and paragraph (4)(b) starts when the dwelling ceased to be occupied.
View history note
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118-150(6)
Once you make the choice, no other *dwelling can be treated as your main residence during the period referred to in subsection (4), except if section 118-140 (about changing main residences) applies.
View history note
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Now back to the idea of applying for a ruling, have a look at TD 92/147 while it applies to construction of a house rather than just an outright purchase it still examines the concept of as soon as practical. In this case you could safely assume that the certificate of occupancy is the same as settlement date in your case.
3. Whether the dwelling becomes the taxpayer’s main residence as soon as practicable after the construction of the dwelling is finished, depends on the facts of each case. The personal circumstances of the taxpayer may be relevant in limited cases only.
Example 1:
4. Kim constructs a post-CGT dwelling intended to become Kim’s main residence. A Certificate of Occupancy issues on 1 March and Kim arranges for furniture and other belongings to be moved in the following day. However, due to flooding, the removalists are unable to carry out their obligations on that date. Kim moves into the dwelling on the earliest possible date after the flooding has subsided.
5. In these circumstances, Kim is taken to have moved into the dwelling as soon as practicable after the construction of the dwelling is finished. In these circumstances, Kim is taken to have moved into the dwelling as soon as practicable after its erection or completion.
Example 2:
6. The construction of Tom’s dwelling is due to finish on 1 June. On 1 May, Tom decides to travel overseas for a period of 6 months. He leaves on 15 May. Although the construction of the dwelling is finished on 1 June, Tom does not move into the dwelling until his return to Australia in November.
7. In these circumstances, a choice that section 118-150 apply to the dwelling cannot be made as the dwelling has not become Tom’s main residence as soon as practicable after the construction of the dwelling is finished.
Example 3:
8. The construction of Mary’s dwelling is due to finish on 1 March. On 11 February, Mary is directed by her employer to go overseas on an assignment for 4 months, leaving on 25 February. The construction of Mary’s dwelling is finished on 1 March. Mary moves into the dwelling on her return to Australia in mid June.
9. As she is required by her employer to go overseas, Mary is taken to have moved into the dwelling as soon as practicable after the construction of the dwelling is finished.



Another relevant point for your ruling application, along the lines of, it can’t possibly mean that you must move in on settlement, would be the EM for section 118-135 which states:
Explanation
The rewritten provision takes account of situations where, for example, there is a delay in moving in because of illness or other reasonable cause.
The exemption does not extend to cases where an individual is unable to move into the dwelling because it is being rented out. However, it would cover a period after the end of the tenancy if the owner could not take up residence immediately because of the nature of repairs required to the dwelling."






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