In 2020 I used an owner occupier loan to buy a residential property which already had a fixed term tenancy agreement in place. I bought the property with the intention to move in and will be doing so when the fixed term lease agreement ends, which will be eight months after I purchased the property.
I expect the property to remain my principal place of residence for many years.
If I were to sell the property in the future, is the method of calculating capital gains tax (where growth is prorated) the only method available?
For example, I have received advice that capital gains tax can be calculated by using a valuation at the time when I move in less the purchase price, and the capital growth from the date when the property becomes my home to the date of sale would be exempted. In this example, as deemed disposal would occur after less than one year (eight months in my case) a 50% discount would not apply.
Are these approaches (the prorated approach and the approach described above) both acceptable ways to calculate capital gains tax in my situation?
In replies to others, I see that your advice mentions that when calculating capital gains tax for a property which has been an investment property since purchase and then becomes a principal place of residence, the cost base can’t be reset. But the advice I’ve received seems to be at odds with that, hence my question to you.
Unfortunately you are stuck with a CGT calculation for the whole time you own it, apportioned between days covered by your main residence exemption and days not. Of course you can’t start to cover it with your main residence exemption while it is occupied by someone else. That is unless you own another main residence and you are using the 6 months over lap rule under section 118-140 which allows you to cover two properties with you main residence exemption back dating up to six months before you sell the original property. Unfortunately, this is only available when you have a choice of properties.
So back to your question section 118-110 describes how you cover a property with your main residence exemption. https://www.ato.gov.au/law/view/document?docid=PAC/19970038/118-110 Moving in is covered by 118-135 https://www.ato.gov.au/law/view/document?docid=PAC/19970038/118-135 as first practical after settlement.
As you can see there is no room for any income-producing activities or someone else living there, unless you fit into one of the carve outs
Section 118-185 discusses how you apportion a gain when the property is not covered by your main residence exemption for the whole time you own it. https://www.ato.gov.au/law/view/document?docid=PAC/19970038/118-185 Basically the pro rata you describe.
Section 118-192 https://www.ato.gov.au/law/view/document?docid=PAC/19970038/118-192 is the reset of the cost base to market value during an ownership period, this is a carve out to avoid section 118-185. As you can see it only covers a property that, up until the date it first earned income, was covered by your main residence exemption, not the other way around.
I suggest you ask anyone telling you that you can quarantine the capital gain up to the market value when you first move in, to give you a section number. They may try section 118-145 the six year rule but this specifically requires you to first cover the property with your main residence exemption before you use it to produce income.
Make sure you make the most of section 110-25(4) which will allow you to increase the cost base by any holding costs while you live there. Examples of this would be rates, insurance, interest, repairs and maintenance. The latter having huge potential from lawn mowing fuel to cleaning materials etc.
All references refer to the 1997 ITAA