Tax Tip 315: Loans and Capital Gains Tax

The amount of debt secured against a property has no bearing on capital gains tax (CGT).

The amount of money borrowed to acquire a property also doesn’t affect CGT.

However, the amount of interest paid in relation to a loan used to acquire a property can affect CGT in some cases. These are cases where someone moves into a former rental property. Another situation might be where the person claims another property as their main residence, using the 6 year rule.


Example 1

In 2018Homer borrows $500,000 against IP 1 to buy IP1 for $600,000. After 2 years he sells the property for $800,000. The buying and selling costs might be $40,000 so Homer has made $160,000 in capital gains.

If Homer had borrowed $100,000 to buy the property it would have been the same result.

If Homer borrowed $620,000 against this main residence to buy the property it would also have been the same result.


Example 2

Homer moved into the investment property, in example 1, after selling his main residence.

From this point onwards Homer should keep track of the interest on the loan that was used to acquire the property as this can be used to reduce the CGT on that property when sold. Interest is a 3rd element cost base expense.

It doesn’t matter which property the loan is secured against.


Example 3

Homer lives in property 1 for a while and then buys property 2 and rents out property 1. After 5 years Homer decides to sell property 1. He had the option to pay CGT on it based on the growth after he moved out or to sell it CGT free by using the 6 year rule. However, if he uses the 6 year rule the property 2 cannot be exempt when it is later sold and in this case Homer would be able to use the 3rd element cost base expenses to reduce, or even eliminate, any CGT on the sale of property 2 – this includes interest on loans used to acquire or improve the property.

 

I am constantly astounded after years and years that almost nobody considers CGT and their "home". The blindly assume its tax free. And next to no tax advisers caution this issue.
Q : How many give their clients the knowledge and a resource to record these costs which can reduce tax ?
A : Next to none. I know of two tax practices that do. We are one of them.

It may be tax free. But for many cases a property that is occupied is still subject to some CGT and failing to account for 3rd element costs is a bit dangerous. And things oftenchange in the future and then you wont have any idea on the missed value. You may only find out after you sell. Fat lot of good the tax advice is at that time.

Rules of when non-deductible ownership costs should be captured and diligently retained
1. Always
2. If Rule 1 wasnt clear enough re-read rule 1.
Worst case you can be wrong. Its not a huge effort. And the cost to maintain the records would even be deductible as cost of complying with tax affairs.

In reality any 100% private main residence could one day in the future be subject to 3rd element costs. Never say...never.

• Property is used to produce any income while it is also a home.
• Property is used as a place of busienss by a sole trader, contractor or partners in partnership
• Some instances where people remarry a person who also owns a main residence. The apparent "home" may only be partially exempt.
• A property that was once a main residence, then a rental and is once again a main residence.
• A property which was not used a main residence from the date acquired eg tenants for one week, one month or a year when first acquired
• A owner uses a choice as Terry describes above. They choose to treat one property that was a home as exempt and the other which produces a negligible gain is taxable.
• A vacant property

As Terry observes interest is the biggie. But also consider rates, improvements and maintenance. Things like - Mowing, repainting, carpets etc

 

If I rent out property A for 1 yr before moving in as PPOR, and say sell after living there for 9 years, while holding property B throughout the period as IP.

1. How is CGT calculated for the sale?
2. Can I claim building insurance for 9 yr to reduce cost base too?
3. Do I still have the option to nominate IP A or B as PPOR for CGT calculation if CG of B is higher ?

Thanks

 

1. Apportioned and historical costbase is used. 1/10th subject to CGT (calculated based on # of days) . Perfect example of when 3rd element CGT costs can be used to reduce the total gain that is then subject to apportioning
2. Yes. The costs of owning an asset include rates, land taxes, repairs and insurance premiums. You also include any non-deductible interest on loans used to finance the asset acquisition
3. A taxpayer who has two properties which are both eleigible for the main residence concessions may choose which property is the exempt one provided the choice is allowed and is factual eg It was eligible and was you MAIN residence and satisfies the maximum 6 year absence rule. eg If you bought the IP in 2015 and commenced to reside in it in 2018 then the period prior to 2018 cant be used for an exemption.

 

Thanks a lot @Paul@PFI

 

Good Day,

I am utterly curious about the rulings for CGT on Main residence.

Lets say I own 6 properties.

I then sell PPOR year 2020 (NO CGT)
I live in property 2 (now my new PPOR for 2 years) then sell (what CGT?)
and repeat till I clear my whole portfolio.

have you studied the potential ways to minimize CGT if this was possible?

Thanks

 

It would depend. If prop 2 was a IP then pro-rata applies. eg If you moved into #2 for a week then its not a main residence at all and the past ownership period is all taxed. If it was a year then prorata profit based on time.

If the properties being sold were constructed by you then GST could apply. And not a CGT asset. This is reflected in TD 92/135.

No, you cant wash away accrued CGT as at any time only one can be exempt on any day.
This needs no ruling. The statutory law is pretty evident.

 

If you have overlapping ownership periods only one could potentially be CGT free. The CGT of the others could potentially be reduced by using the 3rd element cost base expenses as outlined above.