Private ruling: Capital gains tax - main residence
Date of advice: 31 July 2015
Published: July 2015
Ruling period: Income year ending 30 June 2015.
Date scheme commenced: 1 July 2014.

Ruling: Q1: Is the capital gain made on the disposal of the dwelling disregarded? | A1: No. | Q2: Are you entitled to a partial exemption of any capital gain made on the disposal of the dwelling? | A2: Yes. | Q3: Are you entitled to a full exemption on the disposal of part of the dwelling? | A3: Yes. | Q4: Are you entitled to any exemption on the disposal of a part of the dwelling? | A4: Yes.

Relevant facts and circumstances: You and your former spouse purchased the dwelling after 20 September 1985. The dwelling, when purchased, consisted of upstairs and downstairs levels with limited access points between the two. You and your former spouse resided in the dwelling for a number of years until it was leased out. You and your former spouse separated in the same year the dwelling was leased out. The dwelling was rented out for a number of years and then you resumed occupation of % of the dwelling. The financial settlement in relation to your divorce occurred after you had resumed the occupation of the dwelling and your former spouse's share in the dwelling was transferred into your name a number of months after you had moved back into the dwelling. For the purposes of this private ruling, the marriage breakdown rollover under section 126-5 of the ITAA 1997 applies in this situation. Over a number of months after you had moved back into the dwelling, you made a number of alterations to the dwelling to enable you to rent out part of the dwelling: Around five months after you had resumed occupation of the dwelling, you signed a lease for the rental of part of the dwelling. You and your spouse were divorced around three years after you had separated. About seven months after you had rented out part of the dwelling, you moved out of the other part of the dwelling and rented out % of the dwelling. Around twelve months later, you resumed occupation of % of the dwelling. About four months later, you rented out part of the dwelling. You entered into a contract for the disposal of the dwelling and continued to reside in part of the dwelling, with the other part of the dwelling tenanted, until settlement occurred on around five years after you had rented out the other part of the dwelling. You have made a capital gain on the disposal of the dwelling. Your former spouse has made the choice under section 118-145 of the Income Tax Assessment Act 1997 (ITAA 1997), for the period the whole dwelling was rented out, from the date it was first rented out until the day prior to you moving back into the dwelling after your first absence. You have made the absence choice under section 118-145 of the ITAA 1997 in relation to a part of the dwelling for the periods it was rented out, being the first time the whole dwelling was rented out and the period you rented out part of the dwelling.

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 118-110 | Income Tax Assessment Act 1997 Section 118-115 | Income Tax Assessment Act 1997 Section 118-145 | Income Tax Assessment Act 1997 Section 118-190 | Income Tax Assessment Act 1997 Section 118-192 | Income Tax Assessment Act 1997 Subdivision 126-A | Income Tax Assessment Act 1997 Section 126-5

Reasons for decision: Summary: In general, taxpayers are entitled to a full main residence exemption when a dwelling has been their main residence for the taxpayer's entire ownership period in accordance with section 118-110 of the Income Tax Assessment Act 1997 (ITAA 1997). However, the exemption must be reduced if the dwelling was the main residence of the taxpayer during only part of the period of ownership, or if the dwelling was used for income producing purposes. | Detailed Reasoning - Main residence exemption: Section 118-110 of the ITAA 1997 provides that you can disregard a capital gain or capital loss made from a capital gains tax (CGT) event that happens to a dwelling that is your main residence. To qualify for full exemption, the dwelling must have been your main residence for the whole period you owned it, and must not have been used to produce assessable income. However, there are some instances where income producing use is disregarded. | Detailed Reasoning - What is a dwelling for CGT purposes?: For the purposes of the main residence exemption, a dwelling 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 (section 118-115 of the ITAA 1997). A dwelling can include more than one unit of accommodation if they are used together as one place of residence or abode. 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. 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. These 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 shares by the occupants. | Detailed Reasoning - Use of dwelling to produce assessable income: Section 118-190 of the ITAA 1997 reduces the CGT main residence exemption if a part of a dwelling that was the taxpayer's main residence was also used for income-producing purposes for part or all of a period. However, section 118-145 of the ITAA 1997 enables taxpayers to make a choice to continue to treat a dwelling as their main residence after it commences being used to earn assessable income. | Detailed Reasoning - Continuing main residence status after dwelling ceases to be your main residence: If a dwelling that was a taxpayer's main residence ceases to be the main residence the taxpayer may choose to continue to treat it as a main residence in accordance with section 118-145 of the ITAA 1997 (the absence choice). The maximum period that the dwelling can be treated as a main residence is six years if the dwelling is used for income-producing purposes, such as if it becomes a rental property, while the taxpayer is absent. If the dwelling is re-established as the taxpayer's main residence, another maximum period of six years starts to run if the dwelling again stops being the taxpayer's main residence. Once a taxpayer makes the choice, no other dwelling can be treated as the taxpayer's main residence during the period except in limited circumstances, such as a six month overlapping period between when the taxpayer sells an existing main residence and moves into a new main residence under certain conditions. | Detailed Reasoning - Application to your situation: You and your former spouse purchased the dwelling and it was your main residence until you moved out and rented the dwelling for a number of years. You resumed occupation of the dwelling and completed some renovations to the dwelling which enabled you to rent out part of the dwelling. As outlined above, a dwelling can include more than one unit of accommodation if they are used as one place of residence. In this situation, while you had resided in % of the dwelling for various periods, you had also resided in another part of the dwelling while renting out the other part of the dwelling for various periods. Therefore, in accordance with TD 1999/69, it is the Commissioner's view that you disposed of one dwelling, which contained two units of accommodation, being a part of the dwelling and the other part of the dwelling. The Commissioner has reached this conclusion because: • the units of accommodation are connected, • they were incapable of being sold separately; and • you used the two units of accommodation as one dwelling for significantly more than 50% of your ownership period. You have chosen to treat the dwelling as your main residence during all of the periods that you have been absent from it. However, there are two periods where you were occupying one part of the dwelling and the other part was used to earn assessable income. You also vacated the dwelling and made an absence choice after the first of these instances. Subsection 118-190(2) of the ITAA 1997 would only allow you to treat the dwelling as your main residence for 60% of each of these periods. The remaining 40% of each of these periods would be considered to be non-main residence days for the purposes of calculating your main residence exemption. Consequently, you are not entitled to fully disregard the capital gain you made from the sale of this dwelling as it was not your main residence for the whole of your ownership period. Your eligibility to a reduced main residence exemption will be explained below: | Summary: Taxpayers can make a choice to continue to treat their dwelling as their main residence for up to six years for the purpose of the main residence exemption, if the dwelling is used for income producing purposes. Once a taxpayer makes this choice, generally it can only apply to one main residence. | Detailed Reasoning - Detailed reasoning: As outlined above, taxpayers can make the absence choice to treat a dwelling as their main residence even though they no longer reside in the dwelling. If a taxpayer makes the absence choice, they cannot treat any other residence as their main residence for that period. | Detailed Reasoning - Application to your situation: In your case, you had an ownership interest in the dwelling for over ten years. To determine your eligibility to any main residence exemption in relation to % of the dwelling we need to take into consideration your usage of the dwelling during your ownership period, the choices made in relation to the dwelling during your ownership period, and any exemptions available to disregard the capital gain made on the disposal of the dwelling. Under the court order, your ex-spouse's interest in the dwelling was transferred to you in the roles of transferor (your former spouse) and transferee (you). Accordingly the marriage breakdown rollover will apply in this situation. You have stated that your former spouse has made the absence choice under section 118-145 of the ITAA 1997 for the period the whole dwelling was first rented out, around five years after the dwelling was purchased. You have made the absence choice under section 118-145 of the ITAA 1997for the periods the whole dwelling was first rented out and for a period a part of the dwelling was rented out. As outlined above, the absence choice can only be made in relation to one main residence. The renovations undertaken on the dwelling resulted in you having two units of accommodation in the one dwelling. We have taken the following into consideration when determining whether you are entitled to a main residence exemption in relation to the disposal of the dwelling: • your former spouse has made a choice under section 118-145 of the ITAA 1997, as outlined above, for the first period the whole dwelling was rented out, • you undertook renovations to the dwelling which enabled you to rent out the part of the dwelling • you have made the absence choice under section 118-145 of the ITAA 1997 in relation to the dwelling for the period the dwelling was first rented out and the period when the other part of the dwelling was rented out; and • a part of the dwelling has been rented out for various periods during your ownership period. The choices you and your former spouse have made, in accordance with section 118-145 of the ITAA 1997, entitle % of the dwelling to be viewed as your main residence from the date the dwelling was purchased until the date you rented out only part of the dwelling. From the date when part of the dwelling was used to produce income, and you resided in the other part of the dwelling, you cannot make an absence choice in relation to both parts of the dwelling. You can only make the choice in relation to one main residence. You have made the absence choice in relation to one part of the dwelling when it was rented out. As the periods you resided in the dwelling, and the choices you have made in relation to a part of the dwelling cover your entire ownership period of the part of the dwelling, you are entitled to a full main residence exemption on the disposal of that part of the dwelling. Therefore, any capital gain made in relation to the disposal of that part of the dwelling will be disregarded. However, as you cannot make the absence choice in relation to the other part of the dwelling, you are not entitled to a full main residence exemption on the disposal of that part of the dwelling. Based on the facts of your situation, it is the Commissioner's view that while you cannot fully disregard the capital gain made on the disposal of the whole dwelling, for any period that either of the two parts of the dwelling are not eligible for the full exemption, they will be eligible for a partial exemption. That is while a full exemption is available to the disposal of one part of the dwelling, you are not entitled to a full exemption on the disposal of the other part of the dwelling. However, you will be entitled to a partial exemption on the disposal of the other part of the dwelling which is discussed below: | Summary: Taxpayers generally cannot get a full main residence exemption when they use any part of their main residence to produce income during any part of their ownership interest of the main residence. | Detailed Reasoning - Dwelling used to produce income: Section 118-190 of the ITAA 1997 outlines that taxpayers will only get a partial exemption for a CGT event that happens in relation to their ownership interest in a dwelling if: • the dwelling was acquired after 20 September 1985, and it was used as the taxpayer's main residence, • the taxpayer used any part of the dwelling to produce income during all or part of the period they owned the dwelling; and • the taxpayer would have been allowed a deduction for interest incurred in relation to money borrowed to acquire the dwelling if they had incurred it (interest deductibility test). The interest deductibility test applies whether you actually borrowed money to acquire the dwelling. You must apply it on the assumption that you did borrow money to acquire the dwelling. This partial exemption will apply where, for example where a dwelling has been rented out and the section 118-145 of the ITAA 1997, the absence choice, is not chosen or cannot apply. If a taxpayer chooses to continue to treat a dwelling as a main residence for a period under section 118-145 of the ITAA 1997, any assessable income producing use during that period is ignored, to the extent that any part of the dwelling was not used for income-producing purposes just before it last ceased to be the taxpayer's main residence in accordance with subsection 118-190(3) of the ITAA 1997. The amount of the partial gain or loss attributable to income producing use will be calculated under subsection 118-190(2) of the ITAA 1997 by reference to what is "reasonable" in terms of the extent to which the taxpayer would have been able to claim a deduction for this interest. For example, if 10% of a taxpayer's dwelling is used as a place of business and the taxpayer would have been able to claim 10% of the interest on borrowed funds as a deduction, 10% of the capital gain or loss that would otherwise have been exempt will be subject to CGT. However, Taxation Determination TD 1999/66 also points out that a partial exemption for income use can be allowed other than on a floor area basis, such as where it is established that the value of the income producing part of the dwelling as a proportion of the value of the entire dwelling is greater or less than the proportion of the income producing part calculated on an area basis. In this case, the capital gain or loss will be increased having regard to the interest that would have been able to be deducted on the basis of that value, taking into account the time that the area has been used for income producing purposes. Note that where the first income producing use of a dwelling happens after 20 August 1996, the calculation of the capital gain or loss is made under section 118-192 of the ITAA 1997. | Detailed Reasoning - Application to your situation: In your situation, you cannot claim the full main residence exemption on % of the dwelling because you used part of the dwelling to earn assessable income while you were residing there. The choices you and your former spouse have made in relation to the dwelling, as outlined above, have resulted in the whole dwelling being viewed as your main residence from the date the dwelling was acquired until the end of the lease for the period the dwelling was first leased out. However, in accordance with section 118-190 of the ITAA 1997, you only get a partial main residence exemption if part of the dwelling was used for the purpose of producing assessable income during all or a part of the ownership period. Therefore, from the date a part of the dwelling was rented out, you will only get a partial exemption on the capital gain attributable to that part of the dwelling. Note: In accordance with section 118-192 of the ITAA 1997, if you start using part of your main residence to produce income for the first time after 20 August 1996, a special rule affects the way you calculate your capital gain. Where a capital gain or capital loss on a dwelling is subject to a partial exemption because it was used for an income producing purpose and the first income producing use occurs after 7.30 pm on 20 August 1996, section 118-192 of the ITAA 1997 requires the gain or loss that will be subject to the partial exemption for income producing use to be calculated by reference to the capital gain or capital loss that accrued from that first income use time to the disposal time, and not over the whole ownership period. This is achieved by deeming the owner to have acquired the dwelling, or their ownership interest in it, for its market value at the first income use time (subsection 118-192(2) of the ITAA 1997). The capital gain or loss is then calculated by reference to a market value cost base at the first income use time. In this case, the capital gain made on part of the dwelling will be calculated using the market value of the dwelling on the date that the dwelling was first rented out, in this case, the date the whole dwelling was first rented out. The capital gain made on the disposal of part of the dwelling will be calculated using the using the following formula: Capital gain X Percentage of floor X Percentage of period = Taxable area not used as of ownership that that portion main residence part of the home was not used as main residence Note: For calculating the capital gain made on the dwelling, the first element of the cost base of the dwelling will be the market value of the dwelling as at the date the dwelling was first rented out. Any expense/s incurred prior to the date of the deemed acquisition, and any expenses claimed as rental deductions, or able to be claimed as rental deduction in relation to the dwelling cannot be included in the cost base of the dwelling.