Private ruling: Capital gains tax
Published: September 2014
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Questions and answers | 1. Are you entitled to a full main residence exemption on the sale of the dwelling? | No. | 2. Are you entitled to a partial main residence exemption on the sale of the dwelling? | Yes.

Relevant facts and circumstances: You acquired an ownership interest of 50% in vacant land from your spouse. You did not pay any consideration for your ownership interest in the land. A dwelling was constructed on the land within 12 months of you acquiring your ownership interest. You and your spouse moved into the dwelling immediately after the construction was completed and used it as your main residence. You vacated the dwelling 12 months later and the dwelling was rented out for just over six years. The dwelling was sold two to three months after it was vacated. Both you and your spouse consider that the dwelling was your main residence for the whole period from when you acquired your ownership interest.

Relevant legislative provisions: Income Tax Assessment Act 1997 s ection 104-10 | Income Tax Assessment Act 1997 section 110-25 | Income Tax Assessment Act 1997 s ection 118-110 | Income Tax Assessment Act 1997 section 118-125 | Income Tax Assessment Act 1997 s ection 118-135 | Income Tax Assessment Act 1997 s ection 118-145 | Income Tax Assessment Act 1997 section 118-150 | Income Tax Assessment Act 1997 section 118-185 | Income Tax Assessment Act 1997 subsection 118-185(2) | Income Tax Assessment Act 1997 section 118-192

Reasons for decision: Summary: Section 118-110 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you can disregard a capital gain or capital loss made from a CGT event that happens to a dwelling or your ownership interest in it, if you use the dwelling as your main residence. To qualify for a full exemption, the dwelling must have been your main residence for the whole period you owned it. You are entitled to a partial exemption if the dwelling was your main residence for only part of your ownership period (section 118-185 of the ITAA 1997). Further, section 118-150 of ITAA 1997 provides that where you: • acquired an ownership interest in land, and • then built a dwelling on the land, you may choose the dwelling to be your main residence from the time you acquired your ownership interest in the land, as long as the dwelling became your main residence as soon as practicable after the construction was finished, and it continued to be your main residence for at least three months. There is a time limit during which the choice can operate. This is the shorter of four years before the dwelling becomes your main residence, or the period starting from when you acquired your ownership interest in the land and ending when the dwelling becomes your main residence. Section 118-145 of the ITAA 1997 allows you to treat a dwelling (that was you main residence) as your main residence indefinitely, if you do not use it for the purpose of producing assessable income. However, if you do use it for that purpose, you can only treat the dwelling as your main residence for a maximum period of six years while you use it for that purpose. For any period(s) you choose to apply the main residence exemption, you cannot treat any other dwelling as your main residence for that period of time. If a main residence is first used to produce income after 20 August 1996, there is a special rule in section 118-192 of the ITAA 1997 that affects the way in which a capital gain or loss is calculated when the residence is sold. Under the rule, you are taken to have acquired the dwelling at the time you first started using it for income producing purposes for its market value at that time if: • only a partial main residence exemption would be available because the dwelling was used for the purpose of producing assessable income during your ownership period, and • you would have been entitled to a full main residence exemption if you had entered into a contract to dispose of the dwelling just before the first time it was used for the income producing purpose. In your case: • you acquired an ownership interest in vacant land; • you built a dwelling on the land; • you moved into the dwelling as soon as it was completed; • you lived in the dwelling for 12 months; • the dwelling was used for the purpose of producing assessable income for just over six years; • the dwelling was sold two to three months after it was vacated; • you have chosen to treat the dwelling as your main residence from the time you acquired your ownership interest in the land. Please note that short periods between tenancies are considered as part of the renting period, as merely leaving a property vacant for cleaning purposes to put it on the market again does not affect the fact that the property was still being used as a rental property. By applying the main residence exemption rules, apart from section 118-192 of the ITAA 1997, you are entitled to the main residence exemption as follows: • from when you acquired your ownership interest to when you vacated the dwelling; • from when the dwelling was left vacant until it was made available for rent; • for the six year period commencing from when the dwelling was made available for rent; and • from when the dwelling was vacated until the dwelling was sold. From the above, it is evident that there is a gap where the main residence exemption will not apply as the maximum six year rental period has been exceeded. Therefore, the special rule in section 118-192 of the ITAA 1997 applies to you as you are entitled only to a partial main residence exemption and you would have been entitled to a full exemption if you had entered into a contract to dispose of the dwelling just before the first time it was used for that purpose during your ownership period. Consequently, you are taken to have acquired your ownership interest in the dwelling for its market value at the time it was first used to produce assessable income. This figure should be used in your cost base calculations. The application of section 118-192 of the ITAA 1997 does not prevent you making a choice under the absence rule under section 118-145 of the ITAA 1997. This is so even though you can only make the choice for a dwelling that has ceased to be your main residence and even though the dwelling was not your main residence during your new ownership period under section 118-192 of the ITAA 1997. Denying the application of section 118-145 of the ITAA 1997 in these circumstances would essentially render the provision ineffective whenever a dwelling goes from being entirely exempt to entirely income producing and that income producing use lasts for more than six years. This is contrary to the intention of section 118-145 which caps the choice at six years if any single period of income producing use lasts longer than that, but does not operate so as to deny any benefit from the choice if the dwelling is used for income producing purposes for more than six years. An illustration of the application of sections 118-145 and 118-192 can be found in Example 71: Dwelling used to produce income for more than six years and first used to produce income after 20 August 1996 in our Guide to capital gains tax 2013 . You are not entitled to a full main residence exemption as the exemption does not apply to the period where the maximum six year rental period was exceeded. However, apart from the above period, the main residence exemption applies to the rest of your ownership period. Therefore, you are entitled to a partial exemption under section 118-185 of the ITAA 1997. Your capital gain or loss should be apportioned by taking into account your total non-main residence days and the total days in your ownership period as per subsection 118-185(2) of the ITAA 1997. | Detailed Reasoning - Cost base: The cost base of the dwelling should be calculated with reference to the rules contained in section 110-25 of the ITAA 1997 and the Guide to capital gains tax 2013 available on the ATO website. Your calculation should take into account the five elements of the cost base including your proportion of the market value of the dwelling at the time it was first used to produce assessable income, as mentioned above.