Valuation reports - Renting out main residence & moving back into it

Hi guys,

Can you please shed your view on the below scenario? This is essentially the view of my accountant. But wouldn’t mind a second opinion.

Scenario:
1. I purchase my main residence in 2002 for $350,000 and live in until 2005.
2. Then rent it out until 2013.
3. I move back into it for 6 months and then rent out again from 2013 to 2015 and then sell in 2016 for $800,000.

Valuations obtained:
Report 1 at 2005 - $500,000 (date when first rented out - start of 1st 6 yr exempt period)
Report 2 at 2013 - $650,000 (moved back in and start of 2nd 6 year exempt period)

Treatment:
1. CG from 2002 to 2005 - Exempt (non-issue)
2. CG from 2005 to 2013 [CGT on 2 of 8 years] - apportioned at 2/8 years. First 6 years were exempt due to 6 year absence rule and the next 2 years subject to CGT.
3. CGT from 2013 to 2016 - Exempt (2nd 6 year absence rule)

CG subject to CGT
Gain from 2005 to 2013 = $150,000
Apportioned to 2/8 = $37,500

Does this sound right? Any comments much appreciated.

Cheers,
Marcus

 

Where did you live when you were absent and not occupying it as a main residence ? Rental accom ? This is key. The 6 year absence rule consider where you lived when absent.

You also should not use round or proportions of years but numbers of days.

 

Hi Paul,

Thanks for your response.

1. During both absence periods, I was in rental accommodation.

2. Yes. You are correct. It will be apportioned by days (so aprx. 730 days /2920 days x $150,000.

Cheers,
Marcus.

 

OK then. Roughly speaking then the CGT may be worked out as :

Cost base is $500,000 (MV @ 20005)
add : selling costs (legals, agent etc)
add : Ownership costs incurred from which no deduction claimed for period while it was main residence in second period

Selling price - Cost base - Profit
Profit apportioned prorata 2year divided by no of days (2005-sale date)
Resulting CGT profit divided by no of owners
Resulting number divided by 2 (general CGT discount)

So using your example for a single owner = $18,750 taxable subject to selling costs, CGT cost base adjustments

Note if you claimed Depn and CA while it was rented the cost base must be reduced for the amounts deducted. This will increase overall CGT profit prior to discount

 

I would think roughly 8/11ths would be subject to CGT.

First 6 year rule won’t be counted because you were absent longer than 6 years.



Say you sold for $700,000



That is $200,000 x 8/11 = $145k



From this deduct other cost base adjustments and then apply the 50% discount.

 

The 6 year rule is a maximum period. If you are absent eight years then after 6 years CGT applies for the remaining two years.

Section 2 refers to "maximum" : INCOME TAX ASSESSMENT ACT 1997 - SECT 118.145 Absences

 

Paul, I always thought that to be the case, but
see
note 2 of ATO ID 2003/1113

ATO ID 2003/1113 - Capital gains tax: main residence exemption - interaction between the 'absence' rule and the 'first used to produce income' rule

note 1 seems to say the opposite of note 2.

 

Hi Terry,
Thanks. But according to this ATO example below, the first 6 yr period should covered in under the absence rule. But only 6/8 years will be covered.

Using your home to produce income | Australian Taxation Office


Example: Dwelling used to produce income for more than six years and first used to produce income after 20 August 1996

Roya purchased an apartment in Australia for $280,000 under a contract that was settled on 15 September 1994, and immediately started using the apartment as her main residence.

On 29 September 1996 she moved overseas and began renting out the apartment. During the time she was overseas she did not acquire another dwelling and continued to rent out the apartment. After she returned to Australia in July 2014, she sold the apartment for $555,000. Settlement occurred on 29 September 2014 and she incurred $15,000 agent’s and solicitor’s costs.

As Roya rented out the apartment, she is only entitled to choose to continue to treat the dwelling as her main residence during her absence for a maximum of six years; that is, for the period 29 September 1996 to 29 September 2002.

As Roya is only entitled to a part CGT exemption, she first used the property to produce income after 20 August 1996 and she would have been entitled to a full CGT exemption for the dwelling immediately before she started renting it out, she treats the dwelling as having been acquired on 29 September 1996 at the market value at that time, which was $340,000.

Roya works out her capital gain as follows: Refer to link

 

Note 1 refers to apportionment. I.e. where the renting continues after the 6 yr absence period ends. I.e. so if its 8. Only the first 6 would be exempt. This would be based on an apportionment.

Note 2 refers to when the property is first rented out (at point of the deemed acquisition). This I would think is when the first valuation/MV is obtained.

 

Marcus, this example appears to match they way I worked it out above.

 

Terry - Why is the period treated as one 11 yr period ? i.e. from 2005 to 2016.

Subsec 118-145(2) - "you are entitled to another maximum period of 6 years each time the dwelling again becomes and ceases to be your main residence?

Application:
2005 to 2013 - The 6 year exemption applies to 6 of 8 years (note - in 2013, I moved back into the property for a short period of time)
2013 to 2016 - The 6 year exemption applies to 3 of 3 years

Cheers
Marcus.

 

I'm not sure if I agree Terry. Note 1 uses a very clear example of apportioning that 8 year period and clearly states that s118.192 applies when FIRST earns income. Isnt the ID issue about what the costbase is that is used for the apportioning ? Its a question about whether s118-192 applies or the exemption applies and if the exemption is not complete what cost base is used.

Note 2 appears to provide clarity as to WHEN the cost base is adjusted by s118-192 and Notes 1 and 2 are hypothetical to the ID as the taxpayers case was different.

2002-2005 Main Residence exemption applies
2005 Costbase is reset s118-192 to MV on date first produces income
2005-2013 rented

So 2005-2013 = 8 years. 2 taxable. 6 exempt
Then
2013 Main Residence 6mths
2013.5 - 2016 Rented (2.5years)...All 3 years exempt under absence rule

So 2 years taxable for a period of 11 years. Cost base being s118-192 $500K

$800-$500 = $300K
300 x 2/11 = $54545
/2 = $27,272

 

Thanks Paul. I think that sounds correct. However, I'm not sure about the sales proceeds amount you've used.

2005 - $500,000 (MV based on valuation report) - deemed acquisition value
2013 - $650,000 (MV based on valuation report) - deemed disposal value
2016 - $800,000 (sale contract price) - actual disposal price

I would have thought the calc would be:
2005 - 2013 partial exempt ($150,000 x 2/8) = $37,500
2013 - 2016 - fully exempt

I thought the correct method would have been to use deemed disposal value at 2013 rather than the actual sale price of 2016 because, that's essentially the date the property is converted back to MR from being an IP.

 

The first time you rent the property is 2005 so s118-192 applies at that time. The market valuation at 2013 is of no relevance as you are not able to reuse s118-192 again. Prorata applies. The 6 year absence rule does not allow for the cost base to be reset on each occasion either it just is used to determine exempt periods for the prorata. s118-192 applies when a property which has been your main residence since acquisition first earns income. It locks in the cost base.

INCOME TAX ASSESSMENT ACT 1997 - SECT 118.192 Special rule for first use to produce income

The costbase of $500K (and not $650K) is relevant.

 

Found a example used by ATO Treating a dwelling as your main residence after you move out | Australian Taxation Office
Example is right at bottom of a long page of examples and also uses the 6 year rule.

The ATO also clearly indicate that the first income rule in s118-192 only applies to property acquired on or after 21 August 1996. So for property acquired between 20 September 1985 and 21 August 1996 must use a pro-rata method. Property acquired before 20 Sept 195 is a pre CGT asset.

 

Interesting example Paul.

In the from the link Paul quoted directly above, the property was purchased prior to 21 Aug 1996. So the cost base is not reset to the value at the time it first produces income.

But in Marcus' case he purchased in 2002. Therefore the s118-192 should apply. Read it here INCOME TAX ASSESSMENT ACT 1997 - SECT 118.192 Special rule for first use to produce income.

This section basically says the cost base is reset to the market value at the time it first produced income.

So Marcus' cost base would be $500,000 as it was worth this much in 2005.

Then when it is sold s118-185 applies because the dwelling as the main residence for only part of the ownership period.

So the CG will be = CG x (non main residence days/total days in ownership period).

Which would be $300,000 x 2/11 = $54k

And then the 50% discount applied.

so I think Paul was correct above.

 

Message = It does get complex.

 

s.118-192 applies automatically to any main residence that was 100% exempt and first applied to income use after 7:30pm 20 August 1996.

It says nothing about the actual purchase date.

The whole point of this provision is to deem a NEW acquisition date and cost base for CGT.

This also means that a property originally purchased prior to August 1991 can now have third element costs capitalised into the cost base when you move back in.

 

I don't think a private ruling would be necessary, as it is complex to navigate, but a straight forward matter in the end.