Tax Tip 334: The Main Residence Exemption Doesn’t Apply to Property held on Revenue Account

There are 2 broad ways that property profits can be taxed on sale – as capital proceeds, or as revenue proceeds. Property will be held on either capital account or revenue account (or could be a bit of both sometimes).

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Tax Tip 143: The sale of a property – Capital or Revenue account? Tax Tip 143: The sale of a property – Capital or Revenue account?



The main residence CGT exemption cannot apply to property held on revenue account because it is not a capital asset.

Situations where this might occur is someone building houses to sell – whether they are a builder or not.



Example1

Bart still lives at home with his parents and he has signed up to build a house with the intention of living in it for 3 months and then selling.

The main residence exemption would not apply to this situation so even if Bart does move in and establish the property as his main residence the profits would be taxed in full and on revenue account with no exemption available and not even the 50% CGT available were he to hold it more than 12 months.


Example 2

Lisa builds moves into the house for 12 months and then sells, she makes a nice gain which she plouges into the next one. She keeps repeating the process. This is also likely to be revenue account so the main residence exemption may not apply.


Example 3

Maggie builds a house, moves in and moves out and sells. Maggie had the intention to stay there long term, but she meets a bloke and moves into his place and lives happily ever after. This might be capital account and the main residence exemption might apply.


Example 4

Barney buys established homes, renovates them with his labour and sells after 6 months and does this repeatedly. Likely to be revenue account.



In many instances with examples like these people fly under the radar and get away with things, but if audited the ATO might have a different view.



See TD 92/135

 

TD 92/135 is a very simple ruling and many have argued with me that "I'm not a builder". A builder who operates as a sole trader likely operates on revenue account and that isnt often disputed. And a trades person without a licence can still be a "a builder" and the ATO will use the oridinary meaning of builder to me "to build". You need not hold the hammer. However, the issue can be one of a isolated profit making activity. A isolated profit making activity is a matter for income to be taxable as "ordinary income" rather than "business profits". This therefore recognises that there can be three types of property sale - Capital account and then two forms of ordinary income (business profits and isolated profit making). The tax outcomes from the two ordinary income outcomes are almost identical.

The secondary arguement I hear is that I have only built and sold one...there is no repetition. Isolated profit making is just that. The intention to sell for profit or to discharge debt is sufficient. A business likley will have a profit making activity that calls for repetition but that may not be necessary either if there is a comprehensive intention to make profit in a business like manner. And there is no CGT asset as TD 92/135 indicates. Hence no discount and the main residence exemption cant (ever) apply. Even with patience and time. The intentions will be relevant.

In addition, another tax rule applies that should not be ignored. Tax law contains a "tie breaker" that is used when a matter could be taxed as BOTH a CGT event and ordinary income. Tax law specifically ranks the ordinary income as the prevailing tax basis so that the CGT event is reduced so that the ordinary income will be taxed and the CGT event will become $0 so that there is no capacity for a discount (s118-20 ITAA97). The ATO will argue this in their audit decision.

One of the major differences between ordinary income under business profits and a isolated profit making event can be the timing of when the income / profit is recognised. ie Contract date v settlement date. This difference has an ATO admistrative concession which allows a deferred reporting and paying of the tax that is well known by property savvy tax advisers but little known otherwise in my experience.

 

Hi Paul, if I own the property for two years and do the knock-down & rebuild (two duplexes). Is it eligible for the main residence exemption?

Thanks
Kelsey

 

Personal tax advice based on specific taxpayer issues is required. I originally posted to address a potential for it to be either way.

I note your other post which provides further information which is different to this post in terms of its disclosure Under Individual Name or Trust

My revised answer is No. The views in TD 92/135 certainly seem to apply in this situation. The house would not be a CGT asset without further details and consideration being understood.

 

https://www.ato.gov.au/law/view/document?docid=TXD/TD92135/NAT/ATO/00001

 

The question will unlikely apply to both (When you say two duplexes I assume one duplex with two units of accomdation, not four). A duplex is not one asset usually as its rare you can use and occupy both halves. And unlikely to apply to one if the other is sold as a isolated profit making. There can be variations to the general view. I had a interesting one recently. The taxpayer intention from day 1 was to keep one to rent. Keep one to live in. The property demolished was a former home and they loved the street and neigbours and schools etc Then ended up living there approx 18mths then decided to sell the one they lived in to relocate interstate for lifestyle. COVID and WFH was a major factor.

ATO agreed the rented half was a intended CGT asset. And that there was no plan to construct and sell.
The former home was established as a main residence and no intention to profit from the time they bought the land 2+ years ago.
Their intention to construct was predominantly to assist them holding a home and a IP for future income. It was cost effective to knock down to rebuild esp in the suburb they liked as it meant they would retain a similar lifestyle. They had costed this carefully to show the cost of KDR would be less than buying a dual property. ie no duty, no selling costs etc.

Therefore :

• No enterprise. No GST on sale
• No isolated profit making. The decision to sell was a mere realisation attributed to personal lifestyle factors and ability to change jobs and family circumstance
• Main residence exempt
• If and when the rented half is sold it is a CGT asset

The private ruling ensures the view I had is supported and agreed by the Commissioner. Little cost for the outcome

 

I've been thinking about an interesting spin on this, and would like to get some initial thoughts.

Say I buy a PPOR with the intention to live in it and raise my family. X years later I decide to KDR and put a duplex or perhaps townhouses if council permits.

As I understand it, if I do this with intention to sell the end product, I may not be eligible for the CGT exemption.

But what if I am the director of a healthy company with large retained profits that could buy the house from me outright and do the project. Setting aside stamp duty payable, if a related company buys the property from me, would I still be eligible for the CGT exemption. How would the ATO view this?

 

that situation might mean there is a deemed disposal at the point it goes from capital to revenue account so the main residence exemption could apply up to that point.

but it is a common strategy to consider selling to a related entity such as the trustee of a trust or a company. It would cost stamp duty but it can allow for profits to be diverted to more tax efficient tax payers, give more asset protection, and allow for more deductibility of interest etc

 

Thanks Terry, yea this was my assumption/hope that a PPoR could be sold and a CGT event would occur while keeping the main residence exemption to avoid paying any CGT. This way the individual harvests any capital gains up until that point tax free.

The company would then have a new tax base and can treat the build and subsequent sale as business income?

 

It wont be business income. It is a isolated profit making intention. Both business income and and isolated profit making are considered "ordinary income".

The transfer costs of moving the property (legals, duty, CGT - If any ? ) to a company wouldnt normally be a wise choice. You may be over estimating the "profit" that can occur. The small tax savings using a company will be outweighed by the transfer costs. Have also seen big mistakes by people who do this. They demo the old propertty then transfer the land. Can trigger a GST issue.

 

I think it can still be worth doing in some cases. Its best to do the figures and see how it pans out.

One advantage is that it can be hard to ascertain when the taxpayer crossed over from capital to revenue without an ownership change.

 

Yep, agree, you would need to see how the numbers stack up.

 

And if is being sold adjusted for GST