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Background
We downsized 2 years ago and purchased a small, older cottage as our PPR on a large block of land with the intention of doing a renovation/extension. We spent lots of money on initial plans and a bushfire report as we adjoin a small area of bushland. With new building restrictions in force regarding bushfire prone areas, the cost of renovating/extending is exorbitant. We are now considering subdividing the block and selling off the front block. We will probably also sell the rear block (with the cottage) and move on. After reading the booklet How not to be a Developer I would like some further clarification.
1 Would the 50% exemption on CGT apply to the front vacant block as we have owned the whole block for 2 years or would we have to keep the vacant land for 12 months after the sub division is signed off by Council to gain this exemption
2 What cost base would apply for CGT calculations. The whole PPR house and land cost $480K 2 years ago and the sub divided land would sell for possibly $350K. Obviously the PPR would be worth slightly less on a smaller block now (still 900sq m). If we should get a valuation, at what point would we do this
3 Should the sub divided block be put in only my wife’s name as she is not in paid employment. The current PPR is in both our names
Answer
Assumptions- Property less than 5 acres (2 Hectares) in total and has been fully covered with your main residence exemption to date.
The period of ownership starts from when you purchased the original block so you will be entitled to the 50% discount. This is because even though the property has been subdivided it has not changed hands. The catch here is if you do change it over to your wife’s name only then she will have to wait 12 months to get the 50% discount on your half. Further, changing it over to her name will be a CGT event so you will have to pay the CGT up to that point. Which will effectively mean the profit is still taxed in your hands. There maybe an advantage in transferring the whole block into your wife’s name before the subdivision as no CGT would be payable by you because it was covered by your main residence exemption up to that date. First you need to check out the stamp duty involved, normally it would be prohibitive, though there maybe some concessions for transfers between husband and wife if you still keep say 1% of the property. The next trap is that the ATO doesn’t see the transfer to your wife as a scheme with the dominant purpose of a tax benefit and apply Part IVA to void it after you have gone to all the cost of the transfer. So maybe it is better to apply for a ruling first. This may sound over the top but they do try and apply Part IVA to transfers of shares between husband and wife so that the transferring spouse can realise a capital loss to offset against a capital gain, while still effectively owning the shares through their spouse.
Now to the CGT calculation. If it is all in your wife’s name she has to treat it like two assets. One half that she just acquired from you at its market value at the time. The other will go back to the original cost base which I will discuss next when I assume that there has been no transfer to her.
Assuming the property remains in your current names. You will need to get a valuer to apportion your original purchase price between the house and land and the separate piece of land. This is the first element of your cost base, assuming the property has never been used to produce income. You use this ratio to apportion other costs such as legals to buy. Then add to this the cost of any improvements to that portion of the land including improvements during the subdivision such as connecting the water. Note the actual subdivision costs will have to be split between the two blocks because they are a cost of each block obtaining its independent title. Section 110-25(4) will allow you to increase the cost base by the costs of ownership look at lawn moving costs, interest, rates etc over the last 2 years. Part of the bushfire report may qualify to be included in the cost base of the vacant block.
A trick! If the property has been covered by your main residence exemption from the date of purchase then consider using section 118-192 to reset the cost base to the current market value by renting the property out after the subdivision is completed but well before the sale. Providing the tenants have a lease for both blocks then the cost base will be reset to market value at that date, as compelled by law. Even though later as a separate sale you would not be entitled to the main residence exemption on the vacant block its cost base would be so high that by the time you added selling costs there would be no capital gain anyway. This beats changing the property over to your wife’s name only because there are no stamp duty costs and probably no capital gain at all so who cares what tax bracket the owners are in!
I can’t see the ATO trying to apply Part IVA in this case as it is just a consequence of renting the property that is not optional, but set in the legislation. They would look a fool trying to argue that simply letting your home is a tax scheme but cover yourself well here. Make sure it truly is a rental at arms length.
SECTION 118-192 Special rule for first use to produce income
118-192(1) There is a special rule if:
(a) you would get only a partial exemption under this Subdivision for a CGT event happening in relation to a dwelling or your ownership interest in it because the dwelling was used for the purpose of producing assessable income during your ownership period; and
(aa) that use occurred for the first time after 7.30 pm, by legal time in the Australian Capital Territory, on 20 August 1996; and
(b) you would have got a full exemption under this Subdivision if the CGT event had happened just before the first time (the income time) it was used for that purpose during your ownership period.
118-192(2) You are taken to have acquired the dwelling or your ownership interest at the income time for its market value at that time.
Please remember that this answer is only given on the information you have provided. There may be important facts, particular to your circumstances, that we are not aware of. Do not act on this advice alone. Please go over your circumstances in detail with your accountant first.
