If you Demolish your Main Residence and Sell Vacant Land you will probably pay CGT

Lisa purchased a house and land on 1 July 2014 for $450,000. She moved into the property with her family immediately and used it as her main residence until 1 July 2018. On that date she and her family moved out of the property and moved into rented accommodation.

On 1 Sep 2018 the house was demolished. Lisa entered into a contract for sale for the vacant land on 1 Oct 2018 for $600,000.
Can Lisa apply the main residence exemption to the sale and sell the property tax free ?


Main Residence

Under the main residence exemption provisions , any capital gain or capital loss that a taxpayer makes on the disposal of a dwelling that is their main residence is disregarded. The exemption also extends to certain land that is adjacent to the dwelling.

Demolition of Main Residence

Where you demolish a dwelling that you treated as your main residence, no main residence exemption is available from the start of your ownership period of the property to the time the property was demolished, even though the dwelling was your main residence throughout that time. This is because the main residence exemption attaches to the dwelling. When the dwelling is demolished, the main residence exemption is lost .

The main residence exemption can be chosen for a capital gain or capital loss from the sale of vacant land only if the vacant land is sold after the accidental destruction of a dwelling that was the owner's main residence . As the house was not accidentally destroyed by Lisa she therefore cannot apply the main residence exemption.

CGT event A1 happened when the block of land was sold, but this CGT event did not happen to the dwelling. CGT event C1 (about loss or destruction) had already happened to the dwelling when it was demolished. Therefore, section 118-165 applies to deny Lisa a main residence exemption on the capital gain made on the disposal of the land.

Main Residence Absence

There is a general rule that provides that if a dwelling ceases to be your main residence, you may choose to continue to treat it as your main residence in certain circumstances.

If you use the part of the dwelling that was your main residence for the purpose of producing assessable income, the maximum period that you can treat it as your main residence under this section while you use it for that purpose is 6 years. You are entitled to another maximum period of 6 years each time the dwelling again becomes and ceases to be your main residence.

In Lisa’s case she could extend the main residence exemption until a main residence no longer existed. This would extend the main residence exemption to 1 Sep 2018. However at this time no CGT event had occurred.

Unfortunately for Lisa she will pay CGT on the sale of the vacant land and receive no main residence exemption.

 

Hi Mike, can you provide examples of cases where the 6 year main residence exemption would apply? I've heard of young students a few years ago purchasing houses in Sydney, only to return to live with parents (rates, bills etc sent to parents address). Is justification of work relocation or other similar life event typically required?

 

@leeroy Scenario One

Troy and Mary purchased a home in Victoria in 2015. They move in straight away and lived in it for 2 years. They then kept the property, moved to Darwin, rented a house in Darwin and rented out their house in Victoria. They now want to sell their house in Victoria. Will they pay tax on the sale?

In this scenario ordinarily, Troy and Mary would be deemed to have purchased their home for the market value on the date it first used to produce income which was the market value of the property in 2017. They would ordinarily then pay capital gains tax
on the difference between the sales price and the market value of the property when it was first rented.

Troy and Mary will however be able to elect for their house to continue to be their main residence for a period of up to six years, or if the property is not used for income producing purposes after they move out then indefinitely, and therefore if they sold their house from the time they moved to Darwin up to six years later

This concession is sometimes referred to as the ‘absence’ provision or the ‘six year’ rule and does not just apply to moving interstate. It applies whenever you move from your main residence. Even if it’s ‘down the road’.

Where someone makes this choice to apply the absence provisions they cannot treat another property as their main residence. So, if the absence provisions are applied to a PPOR that becomes an IP and they then move into a new PPOR that new PPOR will be subject to CGT at some point in the future.

We have read on forums where some people think that once the six years is up and you go over that six-year period, and don’t sell the property within the six year period, that the absence provisions don’t apply at all. Fortunately, this isn’t true and merely an urban legend.

If you keep renting the property for more than 6 years, you don’t lose the ability to use the six-year rule. Again, another misconception which is out there. You can apply the absence provisions for the first six-year period for which it was rented and then you will be subject to CGT on the remaining period.

 

Hi Mike,
In OP example what if Lisa moved out 30 June 2017 and rented property out immediately until demolition.
Say value at this time is $580k.
Then remainder of calcs as per OP. Ie Held > 12 months as rental before demolition & sale.
What would be the tax calcs be?

The seperate solution to Lisa’s example in OP would appear to be to sell with house intact and discount the sale price for the cost of demolition to maintain MR exemption.

 

Yes Lisa gets to reset her cost base if she rents it out BEFORE the demolition occurs. If you start using your main residence to produce income for the first time after 20 August 1996, a special rule will affect the way you calculate your capital gain or capital loss.

You are taken to have acquired the dwelling at the time you first started using it for income producing purposes for its market value at that time, if all of the following apply:

• you acquired the dwelling on or after 20 September 1985 (post CGT);

• you first used the dwelling to produce income after 20 August 1996;

• when a CGT event happens in relation to the dwelling, you would obtain only a part exemption because the dwelling was used to produce assessable income during the period you owned it; and

• you would have been entitled to a full exemption if the CGT event happened to the dwelling immediately before you first used it to produce income.

In Lisa's case, at the time that the property became income producing she would have been entitled to a full main residence exemption, therefore she will be taken to have acquired the property for its market value when it becomes available for rent.

When a CGT event happens to her property she will work out her capital gain or loss using the market value on the day it became income producing as the first element of her cost base.

 

So working through Lisa’s options (ignoring depreciation, selling costs & 3rd element costs for now);
1. As per OP - CG tax on whole gain of $150k (less say $20k demolition) with 50% discount applying. Tax on $65k could be $32k.
2. Sell as per OP for $580k with discount to allow for purchaser demolition. Main residence applies. Tax = $0
3. Move out & rent for >12 months. Value at first rental $580k. Sold for $600k with $20k demolition cost. Tax = $0.

Rough (& basic) calcs above show that Lisa really should have obtained some tax planning advice and could have saved herself a lot of tax!

 

Lisa thought she knew it all despite marge telling her she should seek others opinions.

 

A failure to plan is a plan to fail.

Murphy's law of tax advice. Ignoring seeking tax advice will cost more than the advice and in 80% of property cases be too late to address the concern after the event.