The CGT main residence exemption

Question

I am a retired Accountant/Tax agent and assist my Brother-in-law and his Wife to prepare their tax returns utilising Etax.This years tax (2012/2013 will be more complicated in that they have sold their Sydney investment property (Quakers Hill).
Period of their occupancy and other data is as follows:
29/03/1996 – Purchased vacant land at Quakers Hill – $96500.00
June 1996 – Approx date construction commenced.
December 1996 – Approximate date of construction completion.
December 1996 – Immediately took up occupation as Main Residence.
June 1997 – Moved to Perth WA and later Karatha WA for Brother-in-laws work as Helicopter Pilot.
1 July 1997 – Rented out Quakers Hill property (no other main Residence). Obtained market valuation $263250.00
12 February 1999 – Engaged Quantity Surveyors to prepare Depreciation Schedules.
January 1999 moved back to Sydney and lived with friends in Paramatta. (No other main residence)
April 1999 Moved overseas to Macau for employment
1 October 2001 Moved back from overseas. Wife and two children moved back into Quakers Hill property as Main Residence. Brother-in -law moved to a rental unit at Wollongbar NSW for work purposes. They purchases vacant land at Wollongbar and built a new Main Residence.
1 September 2002 – Immediately took up residence on completion. Will elect that this be their Main Residence from this date.
4 October 2002 – Start date for second rental period – Quakers hill property.
5 January 2013 – Signed contract for sale of Quakers Hill property.
Sale Price $630000 Agent’s Comm $15750 Legals $1500
17 February 2013 – Settlement Date for Quakers Hill property.
My assessment of Capital Gains Liability:
(1) Total Ownership Period 1July1997 to 17Feb2013 5711 Days
(2) First period of rental 1July1997 to 30Sep2001 1553 Days
Less than six years so MRE applies for full period
(3) Second period of rental 4 Oct2002 to 17Jan 2013 3759 Days
MRE does not apply for this period as will elect that MRE will apply to Woolongbar property from 1 September 2002
Excess days will therefore be 3759 Days
Taxable gain will be $349500 x 3759/5711 = $230042.10
Less : 50% Discount = $115021.05
Questions:
(1) As the Sydney property was acquired in December 1996, do we have to reduce the cost base by the building construction costs claimed, in view of the market value rule which would place the deemed acquisition date after 13 May 1997?
(2) Also as we have to use the market value when first rented as the cost base, do we have to adjust for depreciation claimed on Plant & Equipment?

Answer


Thanks for letting me know you are an Accountant; it makes it a lot easier to explain

The first question you are raising is whether the building depreciation has to be added back to the cost base. As you can see from section 110-45 below it is all about the date acquired.

What does not form part of the cost base
SECTION 110-45 Assets acquired after 7.30 pm on 13 May 1997 View history reference ITAA 36

110-45(1) View history reference

This section prevents some expenditure from forming part of the *cost base, or of an element of the cost base, of a *CGT asset *acquired after 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 1997. (The expenditure mentioned in this section can include giving property: see section 103-5.)

The catch is section 118-192 resets the deemed acquisition date to the date it was first used to produce income, this is not optional

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.
View history note




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.
118-192(3)
If your *ownership interest in the *dwelling *passed to you as a beneficiary in a deceased’s estate, or you owned it as the trustee of a deceased estate and the *CGT event did not happen within 2 years of the deceased’s death, you apply this Subdivision as if:

(a) you had *acquired the interest as an individual and not as a beneficiary or trustee of a deceased estate; and

(b) for applying the formula in section 118-185, your non-main residence days were the number of days in your *ownership period when the dwelling was not the main residence of an individual referred to in item 2, column 3 of the table in section 118-195.
Note:
There are special rules for dwellings acquired before 7.30 pm on 20 August 1996: see section 118-195 of the Income Tax (Transitional Provisions) Act 1997.
View history note




I think it would be worth you applying to the ATO for a ruling on this. While the legislation is clear I have seen the ATO give a positive response when they consider the result unintended.

Section 110-25 (4) allows you to increase the cost base by just about anything associated with the property that you haven’t already claimed a tax deduction for. This probably only relates to the period when they were living there the second time but it would include, rates, interest, insurance, repairs and maintenance. The latter could include cleaning materials light globes and lawn mower fuel. Because the apportionment happens after the capital gain is calculated, effectively costs associated with the time that it was covered with the MRE can partially reduce the gain when it was not.

Section 118-150 (4 year rule) would allow them to cover their new home with their main residence exemption when it was just vacant land. Otherwise they will be stuck with a small CGT liability on the new house, its not the tax but the record keeping. Of course if they take that option the Quakers Hill property will have an even higher capital gain. On the other hand section 110-25(4) will help keep the CGT low because they are living there.

Plant and Equipment are not subject to CGT they are subject to normal income tax so a technically correct CGT calculation would exclude the value of the P&E from the market valuation when first rented and exclude it from the selling price, the ATO will usually accept the written down value in the depreciation schedule.

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