Private ruling: Capital gains tax- main residence exemption
Date of advice: 15 November 2016
Published: March 2017
Ruling period: Income year ending 30 June 20ZZ
Date scheme commenced: 1 July 20YY

Ruling: Q1: Will house 1 and house 2 be treated as one 'dwelling' for the period after you stopped renting house 2 out until you disposed of the properties for the purposes of section 118-115 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Are you entitled to disregard any portion of your capital gain from the sale of house 2? | A2: Yes

Relevant facts and circumstances: You purchased a property prior to 20 September 1985 (house 1). You established house 1 as your main residence after settlement and continued to live in it until you sold it. House 1 contained X bedrooms, as well as bathroom, kitchen, laundry, dining and living areas. You purchased the neighbouring property after 20 September 1985 (house 2). House 2 contained X bedrooms, bathroom, laundry, kitchen, dining, and living areas. You were the only members of your household for the relevant period. You rented house 2 out from the date of purchase until early 20XX. When you purchased house 2 the boundary fence separating it from house 1 was replaced with a fence which ran inside the boundary line of house 2's allotted land. The fence extended from the rear of house 2's carport, to within XX meters of the rear boundary. Another fence ran across from the end of the side boundary so that the back section of the yard and sheds located at the rear of the block (rear yard) were separated from house 2. Your tenants did not have access to the rear yard or sheds. You used the sheds in the rear yard for storage and private purposes for the entire period of ownership of house 2. When you stopped renting house 2 out you started using the house for various domestic activities. You occasionally slept in house 2, and it was used for guest accommodation. The gate in the side boundary fence was left open after your tenants left house 2. No attempt was made to physically join the two houses. You sold both houses under separate contracts in late 20YY. The disposals were settled in early 20ZZ.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 112-25 | Income Tax Assessment Act 1997 section 118-110 | Income Tax Assessment Act 1997 section 118-115 | Income Tax Assessment Act 1997 section 118-120 | Income Tax Assessment Act 1997 section 118-145 | Income Tax Assessment Act 1997 section 118-165

Reasons for decision: Summary: The two houses are two separate units of accommodation and do not constitute one dwelling. You are not entitled to a full capital gains tax main residence for house 2. The normal capital gains tax provisions will apply to the sale of house 2. | Detailed Reasoning - Detailed reasoning: Main residence exemption You may disregard a capital gain or loss that happens to a capital gains tax (CGT) asset (dwelling) where you are an individual, the dwelling was your main residence throughout the ownership period, and you did not acquire your interest in it as either a beneficiary or the trustee of a deceased estate. Whether a dwelling is your main residence is a question of fact to be determined in light of the particular circumstances of each case. Except in limited circumstances, you are generally only allowed to treat one dwelling as your main residence at any time. Dwelling The term “dwelling” is defined in section 118-115 (1) of the ITAA 1997 as a unit of accommodation that is a building, or contained in a building and which consists wholly or mainly of residential accommodation. Taxation Determination 1999/69 (TD 1999/69) considers whether more than one unit of accommodation can constitute a dwelling for the purposes of the main residence exemption. This is possible in circumstances where both units of accommodation are being used together as one place of residence or abode. Whether two or more units of accommodation are used together in this way is a question of fact that depends on the particular circumstances of each case. The factors we will consider in this determination include: ● whether the occupants sleep, eat and live in them; ● the distance between and the proximity of the units of accommodation; ● whether the units are connected; ● whether the units are capable of being sold separately; ● the extent to which the daily activities of the occupants in the units are integrated; ● how the units are shared by the occupants; and ● how costs of the units are shared by the occupants | Detailed Reasoning - Application to your circumstances: In your case, you rented house 2 out immediately after you purchased it. It was not established as your main residence at that time and you are not entitled to treat it as such during the period that it was rented out. After you stopped renting the property out you began using the house for some domestic activities. However, your use of house 2 was not integrated with your main residence to a sufficient degree to support a finding that the two houses were used together as one place of residence, and therefore do not constitute one dwelling for the purposes of section 118-115 ITAA 1997. We consider that the houses are two separate units of accommodation for the following reasons: ● The two houses were completely self-contained and separate. No attempt was made to physically join the two houses. ● The properties were held on separate titles, and were capable of being sold independently of each other. You enclosed some of house 2's allotted land and associated structures for your private use while the property was rented out (rear yard). However, this did not prevent you from using the property to produce income. Additionally, this would not have prevented you from selling the properties to separate buyers, as the fences could have been restored to the original boundary line if necessary. ● You were the only members of your household in the period after you stopped renting house 2 out. The information you have provided indicates that you were both accommodated in house 1 most of the time and generally “lived” in that house. You only slept in house 2 occasionally, and used it mainly for entertainment and guest accommodation. There were no other people accommodated in house 2 after you ceased renting it out, so that there was no integration of the daily activities of the occupants of each house. As the houses are not considered to be one dwelling you are not eligible to claim a full main residence exemption for house 2. | Detailed Reasoning - Question 2: Are you entitled to disregard any portion of your capital gain from the sale of house 2? | Detailed Reasoning - Answer: Yes | Summary: You are entitled to a partial main residence exemption for the portion of the property which you used for domestic purposes in connection with your main residence. | Detailed Reasoning - Detailed reasoning: Adjacent land The main residence exemption can apply to land which is adjacent to your main residence to the extent that it is used primarily for private or domestic purposes in association with the dwelling. The maximum area of land that is covered by the main residence exemption must not exceed 2 hectares. Land which is acquired after you purchase your main residence is also eligible for the exemption, provided other conditions are met. The exemption only applies to the adjacent land if you dispose of it to the same person at the same time as you dispose of your main residence. | Detailed Reasoning - Application to your circumstances: In your case, when you purchased house 2 you fenced off a section at the rear of the yard which included sheds (rear yard). Your tenants did not have access to this area. You used the fenced off land and sheds regularly for domestic purposes associated with your main residence (house 1) for your entire period of ownership of house 2. You disposed of house 1 and house 2 at the same time to the same purchaser. The portion of the house 2's yard which you fenced off and used for private purposes is considered to be adjacent to your main residence, and will be exempt from capital gains tax for your entire period of ownership. Calculating the main residence exemption Taxation determination TD 1997/3 provides that where a parcel of land has been subdivided, the Commissioner will accept any reasonable method of apportioning the original cost base between the subdivided blocks. However, expenditure forming part of the cost base of the asset is not apportioned if that amount is wholly attributable to a particular asset. For example, if a dwelling existed on an original block of land before it was subdivided into two blocks, the cost of the dwelling would only be included in the cost base of the block on which the dwelling stands. | Detailed Reasoning - Application to your circumstances: You did not legally subdivide house 2, however you will need to determine the amount of capital gain which is exempt on a reasonable basis. It is noted that the section which is not eligible for the main residence exemption has a greater area of land associated with it and includes the house itself.