When spouses sell one of their homes

Question

Here are the underpinning facts (I hope I have covered all that you need):

My new wife bought her home (small townhouse on a very small residential block) in Feb 2005 for $330k – and moved into it immediately after settlement as her principle residence
In Feb 2014 – my new wife moved in with me in my principle residence – and at that same time started renting her former home out to tenants. She has been claiming depreciation and other appropriate costs – and declaring the rental income – since that time. Her former home was valued at $550k as at Feb 2014 (and my home was valued at virtually the same amount at that same time).

Last year my new wife accepted an offer and agreed to sell her former home to a developer for $1.1m – settlement to occur 29 June 2018 (at which time it will have been a rental property for a little under 4.5 years)
I bought my home (medium sized home on a 750m2 suburban block) in May 1994 for $138k – and moved into it as my principle residence immediately after settlement (and have lived there ever since – never renting it out or using it as a business premises). Originally this property was in both my name and my former wife’s name (50/50) – but full ownership reverted to me as a result of a binding financial agreement as at 30 Sep 2011 (and my new wife – who of course lives here with me – does not have any ownership of this home)

Although it may not strictly speaking be relevant (as I believe that any potential CGT on my home would be calculated over the entire period of ownership and then prorated over any period that it may not have been eligible for the main residence exemption) – the approximate value of my home in Feb 2014 was $550k … and the current value is around $900k (so it increased in value by around $350k across the period that my wife’s former home increased by around $550k)

Given the very rapid appreciation on my new wife’s property after she moved out of her former home and moved in with me (as opposed to the lower growth experienced in my own home), and given that my wife is currently earning in excess of $120k per annum (so even a discounted CGT bill would carry her well into the top tax bracket) – does it make sense to claim the Main Residence CGT Exemption on her former home for the period 6 Feb 2014 until settlement on 29 June 2018? As best I can tell, this action would avoid any CGT when her former home settles – but would move approximately 4.5 years of future CGT liability onto my home (which we now live in together). I guess that the CGT will catch up with me eventually (if I ever sell) or will catch up with my kids (assuming they sell after I die … although I may be wrong here as I think I have read somewhere that they would inherit it at market value as at my time of death – effectively making any CGT liability magically vanish – is that correct?). Regardless, any potential future CGT payment on my home is put off well into the future (note that I have no plans of selling here in the next decade or more … given that I am 51 and have been here for 24 years so far and continue to be in good health with 2 teenage sons who show no sign of moving out any time soon). Also – would I be able to reduce any eventual CGT burden on my home by subtracting previously unclaimed items such as:

purchase and selling costs and
(assuming I keep good records) any past / present / future costs related to my home (including a $65k extension done around 15 years ago, a $30k renovation done 10 years ago, any interest on loans to buy / renovate, insurance costs, council rates, maintenance / repairs)?

I will hopefully be in the nice position of having little or no taxable income at any potential future time of sale (almost certainly after retirement at age 60 – when I plan to be living off a tax free pension from my super fund) – further reducing any possible CGT burden that might eventually hit me.

About the only downsides I can see with my plan are:

If a future government reduces or removes the 50% CGT discount – it means my net CGT bill will be higher than it otherwise would have been
I have to go back and find a LOT of receipts for money spent on my home over the last 24 years (I have all the big ticket ones – and can find insurance and rates going back at least 15-20 years) – and then need to maintain these and any new ones until any eventual sale (and pass them on if I die … unless I was on the right track above about the CGT liability disappearing when I die?). NOTE that this is something that I am perfectly willing and able to do – as I expect it might yield substantial CGT savings
I have no idea if my decision to expose my home to 4.5 years of CGT liability, will also mean that I have to somehow calculate the depreciation that could have been claimed (but of course was not) on my home across that period (noting that depreciation on the original build is not at issue – as it was built in the 1970’s – but renovations were all done post 1987 so would there be some sort of prorated Div 43 claims associated with them … as well as some Div 40 no doubt as well for various items we have replaced over the years such as dishwashers, ovens, carpets etc). Apologies if I am over thinking things here – as it sounds ludicrous that I should need to consider depreciation when I could never have even claimed it – but it is the tax system after all and it doesn’t always need to make sense

Is there anything screwy with my logic – or does it seem reasonable for my new wife to claim the main residence CGT exemption on her former home … and to move the CGT liability for that period across to my home? I feel like I might have missed something crucial that unravels everything – which is why I wanted to bounce it off an expert.

Answer

Basically you have it right

You are not going to get any reset to market value because your home has not been used to produce income so any CGT calculation is going to go right back to the day you purchased it then apportioned pro rata between days covered by main residence exemption and days not. It is important to make the most of section 110-25(4) ITAA 1997 which allows you to increase the cost base by absolutely everything associated with your property that has not otherwise been claimed as a tax deduction. This even goes as far as cleaning materials, light globes, lawn mower fuel and of course all the obvious things such as improvements, repairs, insurance, interest, rates etc.

Basically disregard the divorce, you are deemed to have been the sole owner of the property during all that time and deemed to have used your original half as you did during that time and deemed to have used your ex wife’s half before the divorce as she did during that time.

A couple only gets one main residence exemption between them but you can choose which property so both properties can be fully covered until you moved in together. Even though you didn’t live there you can elect to give your half main residence exemption to your new wife’s property but of course as you seem to realise that fully exposes your property during that time.

When you go comparing which one is going to have the highest capital gain don’t forget to write back your wife’s depreciation. The basics of course are that your wife can continue to cover the property with hers and your main residence exemption for up to 6 years while it is earning income section 118-145 ITAA 1997. Just to be clear if the main residence exemption is applied totally to her property the depreciation write back is not relevant.

A nice little trick. If you keep with tradition and predecease your new wife leaving the property to her then she will inherit it at market value at the date of your death because it is only in your name section 128-15. Never, never change it to joint tenants. She could then sell it if she wants to downsize, without any of the CGT consequences you would have had.

No depreciation writeback on yours

Yes buying and selling costs go into cost base

Without the benefit of a crystal ball I think you have a very good strategy and from experience are up to the record keeping task just make it electronic and make sure you distribute copies as you go. It looks to me like all the reading you have done over the years will pay off