Tax Tip 318: Can you Claim 3rd Element CGT Cost Base Expenses while living there?

In some circumstance’s costs incurred in relation to a property while you are living in it can be used to reduce CGT when that property is sold.

This is often missed, even by many tax accountants.



The situations where this can arise are when you move into an investment property, or where the property is not income producing, but you choose to claim another property as the main residence, by using the 6 year rule.



Example

Homer moves into an investment property that he owns and rents out his previous main residence for 5.5 years before selling it and using the ‘6 year rule’ to count the sold property as his main residence and avoid CGT.


Later Homer sells the investment property, which he could count as his main residence for part of the ownership period.


When working out the cost base for CGT Homer adds up all usual cost base expenses, but also can include 3rd element cost base expenses incurred while living in the property including rates, repairs and maintenance and interest.

These costs are added to the cost base and it will reduce the gain on the property (but cannot make a loss) resulting in a lower gain which is then apportioned, and the 50% CGT discount applied.



This could result in Homer having one property exempt from CGT and one property on which the CGT is very low, or even nil.

Authority

S110-25 ITAA97

INCOME TAX ASSESSMENT ACT 1997 - SECT 110.25 General rules about cost base



See also PBR Authorisation Number: 1051354650279

 

I find its poorly understood because its complex to identify which properties are affected. And the dangerous bit is many properties today could later be subject to past 3rd element costs. I will explain to assist.

Which property can consider 3rd element CGT costs ?
Any property which is not 100% exempt as the main residence since as soon as practicable after acquisition.
Examples

• The owner/s ran a partnership or sole trader business from home at ANY time during the time they lived there
• The home was ever used to PARTLY produce income eg rented a bedroom, airbnb etc
• A former home has had s118-192 apply and the costbase was reset. And then at any time after, it is used to produce income partly or wholly at anytime in the future.
• You move into and live in a former investmnet property
• You build a granny flat in your own home's yard

What are third element cgt costs ?
Third element cgt costs are non-deductible costs of ownership of the property for which no deduction has been claimed.

Examples : Council rates, building insurance (not contents), repairs and maintennace costs, loan interest and loan fees and borrowing expenses. Missed deductions like arrears of land tax may also be a 3rd element cost. Mowing your lawn and repainting your bedroom are examples of 3rd element CGT costs too.
Example of matters which are NOT third element costs :

• Any portion of a cost that a deduction was claimed for
• Contents insurance
• Water rates and seewer services incl levies
• Notional maintenance eg You "value" the laboutr included in a new deck
• and the big one..........................You dont meet the substantiation requirements eg no receipts or proof !!

3rd Element cost warning

1. Third element CGT costs cant create a tax loss. They can reduce the CGT amount to $0
2. 3rd elements costs prior to s118-192 cannot be used
3. 3rd element costs during a main residence absence may OR may not be eligible. Record them anyway !!

You said many properties could later be subject to 3rd element CGT costs.
Yes.

1. Now for a home which is 100% exempt and then FIRST used to produce rent s118-192 resets the costbase. But any private costs after that time may be 3rd element cgt costs.
eg Luke leaves his home of 4 years and rents it out for 6 months. Then moves back in. He doesnt bother with 3rd element costs as its private right ? WRONG. Lets say in 2 years Luke rents out a roomand does that for 2 years. So while rented he claims 50% of occuancy costs as a deduction. But 100% for the first 2 years and 50% for the last 2 years could add to his costbase. He didnt know. And his accountant never told him

2. David has a 2 bed apartment and lives in it for 4 years. He runs a small business from home in the second bedroom. He doesnt claim any deductions because a friend said he would end up paying CGT. So he missed claiming deductions and will also have a small CGT issue. But he seeks tax advice and learns that ALL of his ownership costs could add to the costbase when he calculates the gain on the 20% of space used by the busienss. He also thinks about renting the whole property out and learns he also can now not use the costbase reset rule in s118-192.

3. Sue has owned her property for six years. Peter has a home he has owned for six years also. peter and Sue meet and fall in love. They eventually move into Peter's home and Sue's property is rented out. Then they decide to rent out both properties. They get tax advice and realise they both ONCE had a main residence exemption but being spouses / defactor's etc means tthat rule stopped. A partial exemption applies to both. BUT each property may also be able to use the 3rd element costs. But neither of them kept records.

and that leads me to my view that property savvy tax advisers are very very easy to spot and pick. They will have and offer tools to assist CGT record keeping. Because they know this happens a lot to the people they advise.

Here is ours. And it includes the space to maintain records about 3rd element CGT costs. Beacuse you never know..........

 

I am still finding tax advisors who claim that 3rd element costs incurred while living there cannot be used to reduce capital gains tax.

this is leading to many to pay more tax than needed.

If you want to read a private ruling on this have a look at this one
Authorisation Number: 1051354650279
Question 2

Do the interest, rates and taxes incurred during the period that the property was your main residence form part of the third element of cost base of the property, where they were not deductible in the year they were incurred?

Answer

Yes

https://www.ato.gov.au/law/view/doc...:Edited private advice&tm=phrase-basic-110-25

 

Does any part of water rates constitute a 3rd element costbase or council rates only?

 

section 110.25 (4) (c) says "rates or land tax. if the asset is land"

this includes water rates

 

The whole water rates figure or do I need to look at the statement and separate out useage charges?

 

Service and supply charges. Not metered use charges. These are a consumption fee not a "rates" charge. On that note I have always queried if electricity supply charges are a form of "rates" and have never seen the issues asked. Note also council rates notices often include bin fees etc and may not be a eligible cost.

The other one many mistake is insurance. Building only.

 

I have had clients get a second opinion with the other adviser call to berate me.

The times when third element costs cannot be added:
1. 100% exempt use. (ie Tip : 3rd element costs can be used when PRO-RATA CGT applies)
2. Prior to a s118.192 costbase reset date. But they can be added AFTER this date.
3. Cannot create a CGT loss (ie you stop counting when the net profit prior to any apportionment = $0)
4. Some occasions when a taxpayer is non-resident (seek property tax advice)

I will often ask a LOT of questions to determine if s118.192 can be avoided. This may radically change the CGT calculations by allowing 3rd element costs and bypassing s118.192 cost base reset concerns. Even a small use of the home to partially produce income is sufficient.

 

which is August 1991

 

agree. usage isnt a rate so no idea why someone would think it was

 

Bumping this topic - I've been given this article by Noel Whittaker in the SMH, he says "all expenses" are able to be added to the cost base.

Is there some distinction between a property never rented and a property rented out in the past (edit: or one that's been main residence & not), or is he just wrong?

 

Discussed third element costs in a recent podcast

Podcast

The key part of your question to Noel was "solely used for private purposes"

 

I wouldn't say all costs. Water - part of a water will is usage. Taking a shower would save you tax if all costs where a cost base expense. Electricity and gas wouldn't be counted either.

Is Noel licensed to give tax advice?

 

Noel isnt qualified to give tax advice that way. He can give financial advice clients limited advice concerning their tax issues.
Due to space its not possible for any article to give all the exceptions and rules. Its a poor source of advice.
He is also likely making the comments in relation to a holiday home which is neither a main residence or producing rental income. A very good example of when 3rd element costs WILL be considered.

3rd element costs are costs for which no deduction has ever been claimed. They are costs incurred for OWNING an asset not those for using the asset. His view ALL costs can be claimed is incorrect. eg "water".
Cost base of assets

 

I was able to include some electricity costs on the basis that the property had a pool and it was necessary to run the pool pump for an average of 6 hours per day:

1.5kW pump, 6 hours = 9kWh per day
35c/kWh = $3.15 per day = $1149.75 p.a.

 

thats an interesting one and can easily see how it is a cost of maintaining the asset. might even have an argument for chlorine, cleaning of pool, etc.

 

What about when one owns an apartment in a complex of say 20 apartments and there is only one water meter for the whole complex.

Each Lot owner is sent a water bill equal to 1/20 of the complex’s water bill, whether they were living there during the billing period or away (eg overseas on a holiday). To me, this is like an ownership cost, not a consumption cost.

In this situation, can “all water costs be claimed”?

 

That just shows how costly pools are!

 

I dont see that view. Water and sewer are services and this cost is merely a reimbursement arrangement to share the total cost and the alternative view if there was a specific basis of metering is you would receive a bill for the fixed service charges + actual consumption. This doesnt relate to ownership. s110.25(4) reads very simply as a "cost of ownership" but includes SOME examples and isnt necessarily inclusive of all examples. You could ask for a ruling on your view.

 

Yes, cost of chemicals can be claimed as well, around $400 p.a.

Also the cost of water can be added:

Evaporation rate in Sydney = 6.4mm per day = 2.336m per year
Subtract rainfall for the year = 1.29m
Nett evaporation - rainfall: 2.336 - 1.29 = 1.046m
Pool area is 4m x 10m, so nett water = 4x10x1.046 = 41.84 m3
Plus add the water used when backwashing the filter = 50L per week = 2.6 m3
Total water usage = 44.44m3 @ $2.24 per m3 = $99.55

So total pool running cost is $1650 p.a. for electricity, water and chemicals

It was DIY pool cleaning when I was living there, when tenanted the weekly cleaning service was $90 = $4680 p.a.

So a fully maintained pool would cost $1650 + $4650 = $6330 p.a. or $17.34 per day!