Private ruling: Capital gains tax - main residence exemption
Date of advice: 8 February 2017
Published: July 2017

Ruling: Q1: Will you be entitled to fully disregard any capital gain made on the transfer of an ownership interest in the houses collectively known as the “House B” to your spouse under Subdivision 118-B of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will you be entitled to partially disregard any capital gain made on the transfer of an ownership interest in the houses collectively known as the “House B” to your spouse under Subdivision 118-B of the ITAA 1997? | A2: Yes. | Q3: Will you be eligible to the main residence exemption on the disposal of your ownership interest in one of the House B houses under Subdivision 118-B of the ITAA1997? | A3: No.

Relevant facts and circumstances: After 20 September 1985, you entered into a contract to purchase an historical property known as “House B” which consists of adjoining independent houses on a single property title. Settlement on the purchase of the House B occurred shortly after the purchase contract had been entered into. House B was rented out for around two years from the month settlement occurred, with each self-contained house being rented out to different tenants. You commenced renovations to convert House B so that it could be used as a single residence in the month that the houses had ceased being rented out. The renovations included the following activities: ● replacing and/or repairing all services and utilities, such as electrics, plumbing, new heating and cooling, gas, internet and phone ● installing new flooring, ceilings where necessary and energy compliant windows ● painting ● removal of walls ● installation of new kitchen, bathrooms and toilets ● installation of new security doors, cameras and alarm system ● installation of new external doors; and ● paving and installation of drainage in rear courtyards. The renovations of House B were completed over a number of months. Until this time, you and your spouse's main residence had been Property A. You entered into a contact to sell Property A prior to moving into House B. You and your spouse commenced living in House B, using the houses as your residence, and expect to use it as your family's main residence for the foreseeable future. Settlement on the sale of Property A occurred during the month after you and your spouse had moved into House B. You and your spouse will be applying the main residence exemption in relation to the disposal of Property in your 201X-1Y income tax return. You intend transferring a specified percentage of your ownership interest in House B to your spouse. You and your spouse intend undertaking the following: ● subdividing House B into lots, with a house located on each lot; ● undertaking the necessary works to make the houses into stand-alone dwellings; ● disposing of one of the houses that is known as House B; and ● residing in the remaining house, which will continue to be your main residence. You and your spouse do not have any intention of undertaking any similar activities in the future. Assumptions This ruling decision has been made based on the assumption that the following will occur during the ruling period: ● Property A meets the relevant conditions for section 118-140 of the Income Tax Assessment Act 1997 to apply ● you and your spouse will apply the main residence exemption in relation to the disposal of Property A in the 201X-1Y income year ● you will transfer a specified percentage of your ownership interest in the houses, which combined make up House B, to your spouse; ● after the transfer, you and your spouse will each have a specified ownership interest in both of the houses known as House B; ● you and your spouse will subdivide the lot on which House B is located into lots, with a house located on each lot; ● you and your spouse will complete the necessary works to make the houses standalone dwellings; ● you and your spouse will dispose of one of the houses and the lot on which it is located; ● you and your spouse will not apply the main residence exemption in relation to the house you sell; and ● the remaining house will continue to be you and your spouse's main residence after the sale of the other house.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 102-20 | 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 118-125 | Income Tax Assessment Act 1997 Section 118-130 | Income Tax Assessment Act 1997 Section 118-140 | Income Tax Assessment Act 1997 Subdivision 115-A | Income Tax Assessment Act 1997 Subdivision 115-B

Reasons for decision: Detailed Reasoning - Questions 1 and 2: Summary You are not entitled to fully disregard any capital gain made on the transfer of the specified percentage of your ownership interest in House B to your spouse. However, you will be entitled to partially disregard the capital gain made on the disposal of the ownership interest. Detailed reasoning | Detailed Reasoning - Main Residence Exemption: Generally, any capital gain or capital loss that arises from a capital gains tax (CGT) event that happens to a dwelling that is a taxpayer's main residence is disregarded if the dwelling was the taxpayer's main residence for the entire period they owned it and has not been used to produce assessable income. If a taxpayer owns more than one dwelling during a particular period, only one dwelling can be their main residence at any one time. The exception to this rule is if you change main residences as outlined below: | Detailed Reasoning - Changing main residences: If you acquire an ownership interest in a dwelling which is to become your main residence before you dispose of your old one, both dwellings are treated as your main residence for up to six months if the old dwelling was your main residence for a continuous period of at least three months in the 12 months before you disposed of it and you did not use it to produce assessable income in any part of that 12 months when it was not your main residence. | Detailed Reasoning - Partial main residence exemption: If a CGT event happens to a dwelling you acquired on or after 20 September 1985 and that dwelling was not your main residence for the whole time you owned it, you may be entitled to a partial exemption. You calculate your adjusted capital gain using the following formula: Capital gain x _________ Non-main residence days________ Total number of days in your ownership period Your non-main residence days are the number of days in your ownership period when the dwelling was not your main residence. Your ownership period is the number of days from the time settlement of the contract to purchase the dwelling occurs until settlement on the sale of the dwelling occurs. | Detailed Reasoning - Main residence exemption - two units of accommodation: For the purposes of the main residence exemption, a dwelling has its ordinary meaning and specifically includes a unit of accommodation that is a building, or is contained in a building, and consists wholly or mainly of residential accommodation, a unit of accommodation that is a caravan, houseboat or other mobile home, and any land immediately under the unit of accommodation. A dwelling can include more than one unit of accommodation if they are used together as one place of residence or abode. Taxation Determination TD 1999/69 (TD 1999/69) outlines the factors relevant in considering whether units of accommodation are used together as one place of residence or abode. Equally, a family that occupies more than one unit of accommodation might be considered to be occupying multiple residences that are independent dwellings. Whether two or more units of accommodation are used together as one place of residence or abode for the purposes of the definition of 'dwelling' is a question of fact that depends on the particular circumstances of each case. If the units of accommodation are used independently, or the use of them changes, then it will be unlikely that they will be considered to be one residence or dwelling. Where two units of accommodation are treated as one dwelling for the purposes of the main residence exemption, and provided they are disposed of under one CGT event and the main residence occupation tests are met, any capital gain or loss realised on the two units of accommodation is disregarded. Actually selling the units of accommodation to different buyers, or selling one and keeping another are significant indicators that they are two separate residences and dwellings. This determination is made at the time of the CGT event as this is when the capital gains provisions apply. Application to your situation In this case, you purchased a number of houses which collectively are known as House B. The houses are each self-contained and are located on a single title. The houses were rented out to different tenants from the settlement date on the purchase of House B until around two years later when you commenced renovation activities to convert the houses so that they could be used as one residence. The renovations were completed a number of months after they had commenced. You and your spouse moved into House B in the same month that the renovations were completed and commenced using the houses as your residences. Prior to moving into House B, you and your spouse had been living in Property A until it was sold, with settlement on the sale of Property B occurring in the month after you and your spouse had moved into House B. You are applying the main residence exemption to the sale of Property A in the 201X-1Y income year. For the purposes of this ruling you will dispose of a specified percentage of your ownership interest in House B to your spouse. It is viewed that your ownership periods in relation to each of the houses commenced when settlement on the contract to purchase the houses occurred and will end when settlement on the sale of each house occurs. Based on the facts of your situation, House B has not been your main residence for the whole of your ownership period of the ownership interest in the houses you intend transferring to your spouse because: ● you had not moved into House B as soon as practicable after you had purchased it; ● you had rented the houses for around two years after the settlement date had occurred; and ● you have made the choice for the main residence exemption to apply to the sale of Property A in the 201X-1Y income year. Therefore, you are not entitled to a full main residence exemption on the disposal of your ownership interest in House B and will only be entitled to partially disregard any capital gain made on the disposal of the ownership interest being transferred to your spouse. However, as outlined above two dwellings can be treated as your main residence for up to six months if the old dwelling meets the relevant conditions and the new dwelling becomes your main residence under the “changing main residences” rule which extends the number of main residence days. In this case, you moved into the houses that are collectively known as House B more than two years after the settlement on the purchase of House B had occurred. Therefore, neither of the houses were your main residence prior to that date. At the time you moved into House B you had more than one dwelling, being Property A which was your main residence and the House B houses. As outlined above, not all of those dwellings can be your main residence for the same period even with the application of the “changing main residences” rule. While you had not moved into House B until over two years after settlement had occurred, you can treat both Property A and one of the houses that make up House B as your main residence from six months prior to the settlement date on the purchase of Property A under the “changing main residences” rule. This will extend the main residence days for the purpose of calculating the adjusted capital gain for the partial main residence exemption on the disposal of only the house you have chosen and not the other house. You will need to determine which of the houses that make up House B became your main residence when you moved into the houses after the renovations were completed as they are viewed as being more than one dwelling for capital gain purposes. We have reached the conclusion that they are multiple dwellings because of the significant period that they were rented to independent tenants and because it is your intention to separate them in the future. Also, you are selling only one of the houses and not all of houses collectively known as House B in the same sale to the same purchaser. Note: As you have held the ownership interest in the houses that make up House B for longer than 12 months, you can reduce any capital gain made on the sale of the ownership interest in the house that is sold by applying the 50% CGT discount to the gross capital gain. | Detailed Reasoning - Question 3:: Summary The CGT provisions consider what you are selling at the time the CGT event occurs. As you are selling a house that is not your main residence, you are not entitled to apply the main residence exemption in relation to any capital gain made on the sale of that house. Detailed reasoning You and your spouse moved into the houses known collectively as House B and have used the houses as your residences. You will transfer a specified percentage of your ownership interest in the houses to your spouse resulting in both you and your spouse having ownership interests in each of the houses. House B will be subdivided into lots, with a house located on each lot. When the subdivision of the House B is undertaken no CGT event will occur as you and your spouse will retain your ownership interests in the lots, being an ownership interest in each lot and the house located on the lot. However, you and your spouse intend selling one of the houses (the Sale House) and the lot on which it is located and will keep the other house/s which will continue to be your main residence. A CGT event will occur on the sale of the Sale House. It is viewed that at the point of sale, the houses will be independent houses and only one of these houses can be your common law main residence at any particular time. While you and your spouse used the houses as your residences during your ownership periods, it is how the Sale House functioned at the time the CGT event occurs. That is, how was the Sale House being used when it is disposed of that will determine if the houses can be considered one dwelling. Based on the information provided, at the point of sale the houses will each constitute independent dwellings. As outlined above, with only a few exceptions only one of those houses can be your common law main residence at any particular time. As you are not selling the houses together it cannot be viewed that the houses can be viewed as a single dwelling. Therefore, as the sale of the Sale House is not the sale of your main residence, the main residence exemption will not apply. Therefore, you will be subject to the general CGT provisions on the sale of your ownership interest the Sale House and any capital gain or capital loss made on the sale of the Sale House will be calculated using the CGT provisions.