Sequence of sales for main residence exemption

Question

Dear Julia,

I have a question about the main residence exemption.

I have two properties which will need to be sold in the next year. I would expect there to be a modest but not insignificant capital gain on both properties.

I purchased property A in September, 2013, and lived in it for 15 months, and it was then rented out. I then purchased property B in December, 2014, and have lived in it until now.

It is my understanding that:
– I can sell property B which I am currently living in, and declare it as my main residence between December 2014 to the date of sale – making it CGT exempt.
– Once property B is sold (and the tenants are out of property A) I can then move back in to property A for a while, and re-establish it as my main residence by living in it for a few months.
– I can then sell property A and claim the main residence exemption on it, making it CGT exempt (despite it having been rented out for two years.

My understanding is if I did it the other way around (sold property A, that is rented out) before selling property B, then only property B would be eligible for the main residence exemption, and the sale of property A would be incur a CGT liability.

Therefore, my understanding is that it would be most advantageous to sell the properties in the first sequence (i.e. sell B, move back into A before selling it), as CGT liability would be completely avoided.

Is my understanding correct?

Many thanks



Answer

No, not exactly but there is a bit of advantage in doing things in the order you suggest. The bottom line is you can choose to cover either property with your main residence exemption but can only cover both at the same time for a period of 6 months and to get that overlap you have to do things the way you have described.
Now I am assuming you do not have a spouse or your spouse does not have any other property.
You can only cover two properties with your main residence exemption for a maximum period of 6 months and that is the 6 months immediately before one of the properties is sold. Further the property that is sold cannot be used as a rental property in the period before it is sold. Much more detail on this in section 118-140 ITAA 1997 but the above is the important part to apply to you. So if you utilise this section you can only do it if the trigger property is property B because it is not being used to produce income. You see there is no restrictions on the property that is not sold, it could have been used to produce income during the 6 months overlap period. So you could sell property B completely covered with your main residence exemption for the whole time you lived there and cover property A for 9 months if you move in there for 3 months after you sell property B
Really you should calculate the gain on each property and look at the numbers more carefully to decide which property you cover with your main residence exemption. You see you could cover Property A all the way through under section 118-145 the 6 year absence rule. Providing property A was covered by you main residence exemption before you moved out of it, you have the choice of continuing to cover it with your main residence exemption for a period of 6 years while it is earning income. Note also that at the time you first used it to produce income you are required to reset the cost base to the market value (and deemed acquisition date) at that time so you are only looking at the gain on property A from December 2014 to the date it is sold. If you also utilise the 6 months overlap and live there for a few months then you need to work out the percentage those 9 or so months are of the total months from December 2014 to the date you sell. It is this percentage of the gain on that house that will not be taxable.
To cover property A for a longer period than those 9 odd months you would need to expose property B to CGT and this might not be a bad idea. The cost base (the cost base is the amount you deduct from the selling price to work out the capital gain) of a property purchased after 20th August 1991 can be increased by any costs associated with holding it that have not otherwise been claimed as a tax deduction (section 110-25(4) ITAA 1997). Many if not all of the costs associated with Property A have been claimed as a tax deduction but not so with Property B because it was your home. So if all else was equal Property B would have a higher cost base than property A. Holding costs include, insurance, rates, interest, repairs and maintenance. The trouble is having the records but you could claim even cleaning materials, lawn mower fuel and light globes.
Now I have given you a lot of information here for you to estimate the best property to cover with your main residence exemption. But in order to keep it comprehendible to someone learning about these issues for the first time I have spared a bit of the detail so please make sure you run your CGT calculations passed your Accountant before you rely on them.

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