Tax Tip 86: Don’t be so fearful of generating income from the main residence

Just want to clarify, the 6 year CGT exemption rule will not apply if I move in to my investment property as my main residence and sell it in the future. Thanks.

 

It could apply from when move out

 

In some cases I actually see a benefit of NOT relying on the 6 year absence rule as the calculation of a capital gain can be small. This can leave a full exemption for another residence which may have a substantially higher taxable gain already accrued.

Too often people assume its better to pay no tax and could easily choose to pay $0 instead of very little but they then leave other property exposed to future CGT. The truth is sometimes paying a very small amount of tax can leave a different outcome.

 

Hi Terry,
What if the IP is converted to PPOR and then convert to IP again and then sold?

How is CGT cost base calculated then when sold?

Thanks

 

Stay tuned - I have a draft tax tip on this written and will post soon - and for PPOR - IP - PPOR again.

 

Thanks Terry, Waiting in anticipation.

 

Specific question on a related scenario - I plan to buy a PPOR in the near future, and rent out ~33-50% of the space on an apportioned basis, soon after buying.

Obviously the main concerns that I need to look at and get advice on are the potential benefit re: cashflow and deductability versus the potential future CGT.

However, it appears that if I was to buy it and then move in, then rent it out subsequently, the cost base would be reset to the value at the first day I rent part of it out (s118-192). Obviously if this was soon after purchase it would be quite disadvantageous, as I'd lose the ability to offset acquisition costs against a future gain, and the cost base would be very similar to my initial payment.

Is my understanding of this correct? Is getting around this a matter of renting out the rooms prior to moving in myself or are there other options I should look at?

 

Love your work @Terry_w, very very helpful tip and one that not a great amount of people would know about! Most would assume that there is no cgt adjustment due to time lived in a investment turn ppor.
Invaluable info right there!

 

Taxpayers may sometimes have more than one property eligible for a CGT exemption based on actual residency or past residency subject to either the 6month overlap rule or the 6 year absence rule.

The taxpayer may then choose which property is exempt subject to a limit which is based on FACT and also eligibility.

In the example given, If a IP becomes a main residence then becomes a IP again then the initial ownership period will always be taxable as the main residence exemption can only apply from the date first occupied as the home. Then when you depart the 6 year absence rule can be chosen if you wish if another property was also your main residence in that period.

The total CGT profit would be pro-rata between taxable and exempt days. However during the period the property is the main residence ownership costs which are not deductible (interest, rates etc) may add to the cost base used to determine total profit

These areas are complex and easy to make errors and both under / over calculate CGT.

 

And also relevant section from your tax tip:

So just to confirm, if you know that you that the sale of a property in the future will be trigerring a CGT event, you can keep a record of all costs including water, electricity, maintenance costs (except things that could have been claimed as depreciating assets), rates, interest on mortgage, land tax, insurance premiums, cleaning, mowing, pest control etc during the time you are living there and add these to the cost base?

Does it have to have been an IP or it that just generally when it is relevent?

I would also be interested in the scenario of IP - PPOR - IP in regards to calculating CGT cost base. I can see this scenario being the most useful if the same rules apply. Any chance you ended up doing a tip on that Terry?

 

If you move into an investment property other capital costs could be used when calculating the cost base, but when you move out of a property the market value is reset when it becomes a rental - different methods.

I have written some draft tips on IP to PPOR to IP and PPOR to IP to PPOR. its in pipeline.

 

Yes correct but note that is water & electricity supply charges and not your own usage amounts.

 

Oh - so only the supply component of the bill?

 

I wouldn't think so.

 

Interesting Terry, are you saying you can include usage as well, or don’t deduct supply & parks fee etc as 3rd element costs?

 

I don't see how electricity costs could from any of the cost base.
What element would it fall under in s110-25?
INCOME TAX ASSESSMENT ACT 1997 - SECT 110.25 General rules about cost base

 

Electricity probably not as no supply charge that i am aware of in Vic.
I was thinking mainly the supply and parks charge on water bill. This is charged regardless if there is no usage so I would believe qualifies as 3rd element cost. S110-25(4).

 

Yes it could be. Note the wording of the legislation:
"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..."

This sounds like it is not limited to the 5 categories of expenses listed.

 

Agree Terry, sounds like we’re on the same page or similar at least!

 

Some traps to third element costs

- If s118-192 (home first used to produce income rule) is used then NO CGT COST prior to that date can be added. s119-192 is the start point.
- Partial deductible costs must be adjusted eg home is place of business
- Who paid the ownership costs (eg small business entity paid them :-( )
- Lack of evidence...many only realise third element costs years and year later
- Blended home loans : Taints all the third element interest. Only portion applicable to acquisition is eligible
- Property acquired prior to 20 August 1991
- Spouse / partner issues where each owned a home prior to living together etc
- Divorce. This can see loss of historical third element costs under CGT concessions

Third element costs can be a compelling reason for some people who depart Australia for extended overseas work to retain their former home and NOT rent it. Unlike the 6 year rule the period of time is of unlimited duration when the property doesnt produce income. The trap however is land tax.