What is our cost base for CGT on PPOR with some income production.

Question

I talked to ATO but still not clear on the cost base.

We bought PPOR in 2004 and moved in asap. Plan to build a 1 bed unit on land but not subdividing. We will rent to a third party so under TD1999/69 it is a separate household. Income will be declarable.

ATO says we apportion house and land value separately to work out the gain when we sell.

Is the cost base on original purchase price or do we get a valuation when we first start to rent out the unit?

If it is on original price ($205 000) do we then apportion the holding costs of the property from day 1?

Info you might need:
PPOR bought with mortgage and current rate is 6.2%
We refinanced and borrowed for renos 3 years ago and currently owe $215 000 on mortgage
Property in one name (highest income earner)
Land is 950sqm
House is 180sqm (220 with carport and patio)
Land to be used for unit 95sqm
Unit 60sqm

Current house value $460 000
Unit construction $100 000
Improvements on common areas (driveway, parking space, garden) $20 000

I hope thats clear enough.

Thank you
Carolyn

Answer

I apologise for the delay in answering this question. When I saw it on Monday afternoon I thought no worries that is simple enough, I will answer it tonight, with a great little trick to solve the problem. Then I started to look through the wording of the legislation to make sure it supported my idea and it was not clear. In the end I decided to get a second opinion, which has just came back to me yesterday afternoon.

Now I must point out that the issue is not that clear and there are no ATO rulings on this particular angle that I am about to explain. But you have my opinion and the opinion of the NTAA’s that the law can apply in this way. To be absolutely sure of course you should apply to the ATO for a private ruling.

Ok so here is the plan:

I assume up to this date the property has never been used to produce income.
I think it will be worth your while to initially use the granny flat as part of your home for the first 3 months after it is constructed. This means the granny flat will start life as part of your dwelling. Then you can use section 118-192 ITAA 1997 (shown below) to reset your cost base to market value for the whole property before you rent it out. That will ensure that you qualify for the full main residence exemption on any capital gains to date. Section 118-192 ITAA 1997 will reset your cost base for the whole property to market value at the date you first rent out the granny flat because you have used the granny flat as part of your home for 3 months after it is completed. Do you have a teenager that you would like to get out of the house for a while and learn to clean up after themselves? Unfortunately it is best to get them back into the home at meal times. Then there is no chance of TD 1999/69 saying that it is two separate dwellings at the point just before you use it to produce income so you can reset you cost base as shown below:

Subdivision 118-B – Main residence
Partial exemption rules
SECTION 118-192 Special rule for first use to produce income ITAA 36

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 View history reference


(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
Hide history note
118-192(2) View history reference

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.




Once the granny flat starts out life as part of your dwelling then TD 1999/69 can never treat it as a separate dwelling unless of course you subdivide and it is sold separately. While the property will still not be fully covered by your main residence exemption while it is used as a rental at least it will be covered in the times it is not and you can effectively use the costs associated with your home to reduce the CGT on the granny flat so I think (no crystal ball) that it will give you a better out come when you sell the property.

Now to how you would calculate the CGT. This is covered in section 118-190. Let’s assume the valuation just before you rent it out, comes in at $600,000 you can then add to this any costs associated with the property that you have not otherwise claimed as a tax deduction since the reset (section 110-25(4)). There won’t be much for the granny flat because you will be claiming all this but for your house there will be and you will soon see how the calculation works to reduce the capital gain on the granny flat with your household expenses. These expenses of course include interest, rates and insurance but they also include repairs and maintenance which means lawn mower fuel, disinfectant, light globes etc. If you can keep good records there may be very little CGT to pay. Example calculation, assume you rent the property out for 8 of the next 10 years and the area (see IT 2167) you claim as being for the granny flat is 30% of the property:

Reset market value cost base $600,000
All costs of ownership for the whole property
That has not otherwise been claimed as a tax
Deduction 100,000
Selling costs 20,000
———–
Cost base at time of sale 720,000
Less Selling Price 750,000
———-
Capital gain 30,000
20% of time not a rental 6,000
———-
24,000
Only 70% of property covered as main residence 16,800
———-
Taxable Capital Gain 7.200
Less 50% CGT discount 3,600
——–
Taxed at marginal rate 3,600

IT 2167 http://law.ato.gov.au/atolaw/print.htm?DocID=ITR%2FIT2167%2FNAT%2FATO%2F00001&PiT=99991231235958&Life=19850704000001-99991231235959
Discusses in detail how you apportion the shared expenses that you can claim against the rent.

If you don’t use Section 118-192 to reset your cost base you will have to calculate your CGT as the ATO said and that would mean no main residence exemption on the capital gain to date on the land under and around the granny flat. You see you cannot use 118-192 if they are considered two separate dwellings right from the start because your home is not actually used to produce the income.

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