Tax Q&A: Determining CGT payable

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Q: My husband and I have been finding it difficult to determine the amount of CGT payable (if any) on part of our PPOR if we rent out that part of it for less than six years. Specifically, we have a block of land that is 630sqm, a single title with a duplex. We purchased it last year (April 2016). Directly after purchasing the property, we started living in one of the apartments (180sqm) and will continue to do so while renting out the other (80sqm).

We plan to build a new 80sqm loft on top of our garage (including bedroom and kitchenette) and may rent it out to my husband’s business as an office space for five years, then return it to the PPOR as a bedroom for our teenagers. 

Questions: 

1. If we sell the property and cease leasing both the apartment and the loft within six years, will the six-year rule apply?
2. If not, how will CGT be calculated on a) the leased apartment, b) the garage loft?

- Regards, Patricia

A: In general, your main residence (home) is exempt from capital gains tax (CGT). You must occupy and use the dwelling as your home. A mere intention to occupy or construct a dwelling to use as your main residence without actually doing that is not sufficient to obtain the exemption. 

With multiple dwellings, the issue is more complex, especially if they have different usages.

The main residence exemption requires a dwelling to exist on the property that is being sold. If a block of land is divided, the land that you sell is not part of your home and therefore typically not part of the exemption. Therefore, any profit on the sale of this land would attract CGT.

You cannot usually obtain the full main residence exemption if you:

• acquired your dwelling on or after 20 September 1985 and used it as your main residence, and 
• used any part of it to produce income during all or part of the period you owned it, and
• would be allowed a deduction for interest had you incurred it on money borrowed to acquire the dwelling (interest deductibility test).

Only a partial main residence exemption is available for a dwelling if it was the taxpayer’s main residence for only part of the ownership period. Generally, the full exemption is proportionately reduced by taking into account the period in which the dwelling was not the taxpayer’s main residence (non-main-residence days).

To work out the taxable capital gain, the taxpayer should apply the same process to proportioning the capital gain or loss as they would to claiming a deduction for interest. In most cases, the taxpayer can use both the:

• proportion of the floor area of the dwelling that is set aside to produce income, and 
• the period in which the taxpayer used it for this purpose.

If a taxpayer starts to use their home to produce income for the first time after 20 August 1996, there is a special rule for working out the taxpayer’s capital gain or loss. In this case, the taxpayer is taken to have acquired their home at its market value at the time that it was first used to produce income, if all of the following apply:

• the taxpayer acquired the dwelling on or after 20 September 1985
• the taxpayer first used it to produce income after 20 August 1996
• the taxpayer would only get a partial exemption because the dwelling was used to produce assessable income during the ownership period, and
• the taxpayer would have been entitled to a full exemption if they had sold the home immediately before they first used it to produce income.

A taxpayer may continue to treat their home as their principal residence when they are absent from the home. Where a taxpayer chooses to rent out their home or part thereof, they could still be entitled to the full main residence CGT exemption.

The tax legislation allows you to maintain the CGT exemption on your main residence if you have a ‘temporary absence’ of up to six years, as long as you are not claiming another property as your main residence at the same time. 

In the case where a family member occupies a separate dwelling within the property on  a non-commercial basis and the home is later sold, a full CGT main residence exemption will still be available. This is because the CGT main residence exemption extends to “adjacent land” of up to two hectares from the main dwelling, provided it “was used primarily for private or domestic purposes in association with the dwelling”.

However, if the separate dwelling was leased at commercial rates, a partial main residence exemption would be triggered on the basis that the dwelling was being used for producing assessable income.

If the dwelling is your main residence and you use any improvements as part of your home, they are still exempt. This includes improvements on land adjacent to the dwelling (for example, a swimming pool that you installed) if the total land, including the land on which the home stands, is two hectares or less.

"Where a taxpayer chooses to rent out their home, they could still be entitled to the main residence CGT exemption"

However, if the dwelling is not your main residence or you used the improvements to produce income for any period, the part of any gain that is attributable to the improvements for that period is taxable.

When you dispose of the dwelling, you calculate the capital gain or capital loss on the major improvements by taking away the cost base of the improvements from the proceeds of the sale that are reasonably attributable to the improvements.

Coming back to the questions based on the above:

Question 1: As you did not initially occupy either the leased apartment or the new loft as part of the main residence, they would not meet the six-year test requirements.

Question 2 (a): As you never occupied the leased apartment it cannot be included as part of the main residence, so the capital gain will be fully taxable and calculated by taking its proportional size relative to the total size multiplied by the total capital gain on a sale. As you have owned the property for over 12 months and purchased with the intention to retain then you would be entitled to the general 50% CGT discount. 

Question 2 (b): As your original use intention for the just-built loft on top of the garage is to be for investment purposes the capital gain would be taxable in the proportion of days tenanted to total days owned. The final calculation will need to apportion the loft to the total home. If on the other hand the loft is initially used as part of your home, then any CGT on the sale of the site would be calculated taking into account the market value at the time it first became an investment compared to its proportion of the whole and the time it was so used as an investment, less the apportioned costs. Please note that the 12-month rule before the 50% discount could apply if moving from home to investment use and a subsequent sale. If it is initially used as part of the home then the six-year rule could also apply.  

There are several nuances and strategic decisions that you need to consider before deciding on a final strategy for the site as the tax outcome will be quite different based on pursuing a particular path. I suggest you seek specific advice and look at various options before making a final decision, especially as the property is only on one title.

Ken Raiss 

is director of  Metropole Wealth Advisory

Disclaimer: The advice contained in this article is for general information only and should not be taken as financial advice. Please make sure to speak to a qualified professional person before making any investment decision.