Tax Tip 240: Buying a Main Residence which is initially tenanted and CGT.

Discussion in 'Accounting & Tax' started by Terry_w, 7th Sep, 2019.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    Imagine you buy a property with the intention of moving in, but there is a tenant whose lease doesn’t expire for another 6 months so you keep renting and wait for them to move out so you can move in.

    What are the CGT consequences of this?

    Well, that property will always be subject to CGT as you did not move in straight after purchase.

    But all is not lost because CGT will be minimal to almost nil where you remain living in the property for a number of years. Furthermore 3rd element cost base expenses can be used to reduce CGT even further.

    Example
    Homer buys 123 Smith Street, but the contract indicates it is not vacant possession. It will come with a tenant with 6 months left on the lease.


    Contracts signed on 1 July 2019, but Homer doesn’t move in until 1 Jan 2020, with a hangover.


    Let’s say Homer sells that property in 2030, signing contracts on 1 July.

    Will he pay CGT?

    He might, but it may be a very small amount.

    The first thing to consider is to work out the time period it was rented as a percentage of the total ownership period.

    6 months/132 months = 4.5%.

    So, at most the capital gain would be 4.5% x 50% x the gain or 2.27% of the gains on the property. Bugger all – note the 50% is the 50% CGT discount applied for holding the property for more than 12 months.

    But before this is done, the cost base has to be worked out. The capital gains are the sale proceeds less the cost base.

    The cost base expenses include buying and selling costs and, importantly, the interest, rates, repairs and costs while living in the property can be taken into account here and they will further reduce any CGT, potentially bring it down to nil as over 11 years these costs would add up.
     
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  2. Mike A

    Mike A Accountant Business Member

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    homer might be able to use the six-month overlap rule to reduce it to nil
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    But only if he sold another property
     
  4. Phar Lap

    Phar Lap Well-Known Member

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    I presume we are talking about in Australia.....cause I dont know anyone in Oz named Homer.:D
     
  5. datto

    datto Well-Known Member

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    Or Bart. Well not many.
     
  6. Mike A

    Mike A Accountant Business Member

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    Plenty of marges in the druitt however
     
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  7. Invest_noob

    Invest_noob Well-Known Member

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    What if homer signs the contract on 1 July 2019 but negotiates a settlement date of 1 Jan 2020 and moves in on that date, would he still be liable for CGT for that period?
     
  8. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    No because he would have moved in as soon as practical. s118-135 itaa97
     
  9. Invest_noob

    Invest_noob Well-Known Member

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  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    That is correct. CGT works, generally, on the date of the contract. But a person cannot move in until settlement so s118-135 applies to count from the contract date to the settlement.
     
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  11. pc117

    pc117 New Member

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    Hi @Terry_w ,

    Firstly, really appreciate all your input with the tax tips (and Paul's usual follow ups!).

    Can you please post a reference to the legislation for the ability to increase the cost base with costs incurred after you move in and the tenant has left (i.e. for the time it was your main residence)?

    I would have assumed that any costs incurred after you move in would be personal in nature and not taken into account for CGT purposes. As you said, for the example above, adding things like interest and repairs for the years that you were living in it is likely to be very substantial and would likely reduce the CGT to nil, or v close to it.

    Thanks
     
  12. Mike A

    Mike A Accountant Business Member

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  13. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    Of course the cost base which comprises the sum of each of the elements may also be reduced too. Or modified.

    3rd Element costs are :

    s110-25 (4) The third element is the costs of owning the * CGT asset you incurred (but only if you * acquired the asset after 20 August 1991). These costs include:
     
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  14. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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  15. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    I'm often asked by people where is the ATO guidance on other costs like land tax. council rates etc which arent mentioned ?

    The ATO consider that the terms of s110-25(4) contain a reference to ownership costs generally (maintaining ownership as well as functionality) and those for which no tax deduction has been claimed which are ownership costs are also eligible. This is found on their website and is a public ruling. It does not include consumption costs like water, sewer, electricity, gas or telecommunications.

    The costs of owning an asset include rates, land taxes, repairs and insurance premiums [QC 52174]

    Other examples not quoted could be a proportion of borrowing expenses, loan break fees, DA costs and more. Depreciation is not eligible.
     
  16. kierank

    kierank Well-Known Member

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    Say one rents a property for first 4 years, then lives in it for the next 16 years, then sells it.

    We all know what sorts of records should be kept for the first 4 years (standard rental situation).

    What sorts of records should be kept for the next 16 years?

    Paper records filed by FY?

    Spreadsheet acting as a document register?
     
  17. Scott No Mates

    Scott No Mates Well-Known Member

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    I do, I've even got him on my LinkedIn contact list.
     
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  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    All r cords should be kept, especially evidence of rates, strata, repairs, interest etc incurred while living there as these will reduce any cgt
     
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  19. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    Exactly the same ones. The ATO expects you to keep all the property records until the asset has been disposed of + 5 years. Scans yes. Paper is bad. A updated summary as well.

    Our CGT record tool includes this for this precise reason. We encourage all property owners for EVERY property to maintain records from day one. And keep records of refinancing on loans if the ATO ever ask !!!

    Its easy to accidently miss 3rd element costs. And exact dates too.

    Eg Mike and Mary buy a home and live in it from day one. 18 month later Mike starts a home based business (Amazon) as sole trader with 15% of the home dedicated as storage and office. Then Mike and Mary a year later leave AU to work in the USA for 3 years and rent the home. Later they return and reside there once again.

    s118-192 does NOT apply to reset the costbase at the time the home first produces income !! and all the former private costs are now eligible from the time they commenced to own it yet nobody realised it and they werent aware for 6 years that this was a benefit. 100% of some costs will add to the costbase and 85% of some other period of time. Then 0%.
    If they maintained the CGT record it may have been avoided

    Tip : 3rd element costs can only bring the CGT profit to $0. No losses.
     

    Attached Files:

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  20. kierank

    kierank Well-Known Member

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    So, after the tenants have moved out (i.e. property is no longer a rental) and before one moves in (i.e. property is going to become one's PPOR), if one paints the internals of the property and replaces the carpet, what is the correct tax handling of these two repairs?

    Am I correct is believing that:
    1. The painting is an operational expense associated with the period when the property was a rental and hence, claimable as a deduction in that FY?
    2. The carpet replacement would be an ownership cost and can be used to increase the CGT cost base when the property is sold?
    Just trying to get my head around this.

    We could be in this situation in the next 12 months to 2 years. I would like to get my understanding correct before catching up with our accountant/tax advisor.