Private ruling: Capital gains tax - main residence
Date of advice: 22 February 2016
Published: April 2016
Ruling period: Income year ending 30 June 2016; and | Income year ending 30 June 2017.
Date scheme commenced: 1 July 2015.

Ruling: Q1: Was the new dwelling built on the property (the new dwelling) your main residence for capital gains tax purposes from the date the contract for the construction of the new dwelling was signed until seven months before settlement on the disposal of Property B occurred? | A1: No. | Q2: Was the new dwelling your main residence for capital gains tax purposes from the date six months prior to the settlement on the disposal of Property B occurred? | A2: Yes.

Relevant facts and circumstances: You purchased the property prior to 20 September 1985 (Property A) where you resided. The opportunity arose for you to purchase the property located next door to Property A (the Property). The contract of purchase for the Property was signed after 20 September 1985. Your career is involved with designing and your partner is involved in a similar area of occupation. You had thought that the Property was an ideal site for the construction of a dwelling to be not only your residence, but also to be a showcase of your work. Property A was disposed of a number of years after you had purchased the Property. The Property had an existing dwelling located on it (the original dwelling), which you rented out on a casual basis or let friends stay in it while they were holidaying or visiting you for a number of years after you had purchased the Property. The original dwelling was never your main residence. You commenced renting out the original dwelling on a formal basis a number of years after you had purchased it, with a portion of the Property being available to the tenant. The area available to the tenant was farm fenced and gated off from the rest of the property and you had claimed deductions for all of the ownership costs for the Property. A contract for the construction of a new dwelling (the new dwelling) on the Property was signed over six years after you had purchased the Property. You purchased property (Property B) around seven years after you had purchased the Property. The building construction works on the new dwelling were largely completed around eight years after the Property had been purchased, with the finishing details being completed around twelve years after the Property had been purchased. The cost of the construction of the new dwelling was met by your family trust, which has also met the outgoing costs associated with the property and paid you a nominal rental amount per year under your arrangement. You moved into the new dwelling once it was habitable around eight years after the Property was purchased. Property B was sold over eight years after you had purchased the Property and you claimed the full main residence exemption in relation to this property in your assessment in the income year in which Property B was sold. You used a short-term rental property as your base for a period of time when you working away from the Property after Property B had been sold until you purchased another property (Property C) which you then used as your base when working away from the Property. The original dwelling was rented out until around eight years after the Property had been purchased and was demolished around six months later. The Property and the new dwelling are currently on the market for sale. For the purposes of this private ruling, you will dispose of the Property and the new dwelling during the period covered by this private ruling.

Relevant legislative provisions: 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 118-150 | Income Tax Assessment Act 1997 Section 118-185 | Income Tax Assessment Act 1997 Section 118-190

Reasons for decision: Summary: This private ruling applies to the new dwelling and the Property land and not to the original dwelling. Therefore, we have considered the capital gains tax (CGT) implications in relation to the new dwelling and the Property land as follows: | Detailed Reasoning - Main Residence Exemption: All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise noted. In certain circumstances, there may be an exemption that can apply, which means that the gain or loss created by a CGT event is disregarded. Exemptions from CGT are set out in Division 118. In particular, Subdivision 118-B contains the CGT main residence exemption. The exemption disregards a capital gain or capital loss a taxpayer makes from a CGT event that happens to a dwelling, or their ownership interest in a dwelling, which is their main residence under section 118-110. A capital gain or capital loss you make from a CGT event that happens to your main residence is disregarded if: • you are an individual • the dwelling was your main residence throughout your ownership period the property was not used to produce assessable income, and • any land on which the dwelling is situated is not more than two hectares. For the purposes of working this out: • the term dwelling includes the land under the unit of accommodation as well as the physical building; and • the reference to ownership period includes ownership of land on which the dwelling is later built. If a taxpayer owns more than one dwelling during a particular period, only one dwelling can be their main residence at any one time. | Detailed Reasoning - Application to your situation: You purchased the Property with settlement occurring after 20 September 1985. You rented out the original dwelling on a casual basis, or let to friends, for a number of years after the Property had been purchased, and then on a formal basis from around five years after the Property had been purchased. You commenced building the new dwelling on the Property around six years after the Property had been purchased and moved into the new dwelling around eight years after the Property had been purchased. You purchased Property B over six years after you had purchased the Property and disposed of it around two years later. You claimed the full main residence exemption in relation to Property B in your assessment in the income year in which Property B had been sold. As outlined above, you can only have one dwelling as your main residence at any one time. In your case, you did not move into the new dwelling until eight years after you had purchased the Property. Property B was your main residence for a number of years, as evidenced by your assessment in the income year that you sold Property B, and for that period no other dwelling could be viewed as your main residence unless one of the exemptions applied. We have considered whether any of the rules that may extend the main residence exemption will apply to the new dwelling as follows: | Detailed Reasoning - Constructing a dwelling on land you already own: If you build a dwelling on land you already own, the land usually does not start to qualify for the main residence exemption until the dwelling becomes your main residence. Section 118-150 deals with building, repairing or renovating a dwelling on land in which a taxpayer has an ownership interest. This section enables you to choose extend the main residence exemption for the dwelling to include the shorter period 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. However, you can make this choice only if the dwelling: • becomes your residence as soon as practicable after the dwelling is built, repaired or renovated; and • continues to be your residence for at least three months. | Detailed Reasoning - Application to your situation: In your case, the shorter period in your case is the four years before the new dwelling became your main residence. However, Property B was your main residence for a number of years for capital gains purposes, from around seven to nine years after the Property was purchased. Consequently, the new dwelling could not also be your main residence for capital gain purposes when you first moved into it and you cannot make this choice in relation to it. Therefore, this section will not extend the main residence exemption in relation to the new dwelling and you cannot treat the Property land as your main residence for the period prior to the date you moved into the new dwelling. | Detailed Reasoning - Changing main residences: If a taxpayer acquires a dwelling that is to become the taxpayer's main residence and the taxpayer still owns an existing main residence, both dwellings are treated as the taxpayer's main residence for up to six months in accordance with section 118-140. However, this rule only applies if the taxpayer's existing main residence was the taxpayer's main residence for a continuous period of at least three months in the 12 months before it was disposed of and it was not used for income-producing purposes in any part of that 12-month period when it was not the taxpayer's main residence. | Detailed Reasoning - Application to your situation: Property B was your main residence for a number of years until it was disposed of, which was during a period after you had purchased the Property. You moved into the new dwelling around eight years after the Property had been purchased. Based on the information provided, the changing main residences rule will apply in your situation. As a result, both Property B and the new dwelling can be treated as your main residence for up to six months before Property B was disposed of. Therefore, the new dwelling will be viewed as being your main residence for capital gains purposes from six months prior to the settlement on the disposal of Property B. | 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 are entitled to a partial exemption. You calculate your 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. The ownership period commences from the date that you had an ownership interest in the house or the land on which the house was built. That is from the time that you had a right to occupy the land until settlement upon disposal of the land. | Detailed Reasoning - Application to your situation: Your non-main residence days will be the period from the date of settlement on the purchase of the Property until the date six months prior to the settlement on the disposal of Property B. Your total number of days in your ownership period will be the date that settlement on the purchase of the Property occurred and the date that settlement on the disposal of the Property and the new dwelling occurs. While you are entitled to a partial main residence exemption in relation to the new dwelling, we need to consider the CGT implications in relation to the Property land. | Detailed Reasoning - Property land: The Property land had not been used in relation to the new dwelling until the construction of the new dwelling was commenced over four years after the Property was purchased. The original dwelling had been rented out, with a percentage of the Property land being rented out with the original dwelling. Therefore, we need to consider any CGT implications arising due to part of the Property land being used to produce assessable income as follows: | Detailed Reasoning - Use of dwelling for producing assessable income: A capital gain or capital loss that you have made from a CGT event which happens in relation to your dwelling will be increased if you used it at any time for the purpose of producing assessable income. The capital gain or capital loss is increased by an amount that is reasonable having regard to the extent to which interest would have been deductible if you had borrowed money to acquire the dwelling. This is a hypothetical test which assumes that you had borrowed money to acquire the dwelling and had incurred interest on the money borrowed. You are entitled to a deduction for interest to the extent to which you use the dwelling as a place of business or use part of it to derive rental income. The Commissioner will normally increase the capital gain or capital loss on the basis of floor area, taking into account the period during which the area has been used for income producing purposes | Detailed Reasoning - Application to your situation: The Property land was not used in relation to the new dwelling throughout all of your ownership period for private purposes. Therefore, the capital gain or capital loss that you would have made apart from this section from the CGT event, such as the disposal of the new dwelling, is increased by an amount that is reasonable having regard to the extent that the Property land was not used in relation to the new dwelling. While you had not used the new dwelling to produce assessable income, but had used the Property land in conjunction with the original dwelling, the method for adjusting and apportionment as outlined in section 118-190 of the ITAA 1997 will be used in relation to the CGT calculation for the Property land. | Detailed Reasoning - Calculation of capital gain on the disposal of the new dwelling and the Property land: The capital gain on the disposal of the new dwelling and the Property land will be calculated as follows: Step 1. Apportion the Property into its two parts Technically, you only perform one calculation in respect of the sale of an asset however, in your case the changes in use during your ownership of the Property mean that it is easier to do as two distinct parts. The Property should be apportioned to account for the area of the Property land that was used in association with the original dwelling, the tenanted area, and the remaining are of the Property (including the new dwelling). Both capital proceeds and cost base elements are to apportioned on a reasonable basis. Step 2. Calculate the capital gain Capital proceeds Less The cost base, which will consist of: • The purchase price of the Property land in the first element of the cost base • The ownership costs in the third element of the cost base; and • The amount you incurred as the cost of construction of the new dwelling in the fourth element of the cost base. The first element of the cost base of the Property will need to be apportioned on a reasonable basis to account for the Property land and the original dwelling. Also, any amounts claimed as deductions, or which can still be claimed as deductions, in relation to the Property land and the original dwelling cannot be included in the cost base. Similarly, only amounts that you have personally incurred can be included in the cost base. Expenses paid by your family trust cannot be included in the cost base. Step 3. Calculate the number of days in the ownership period This is the total days in the ownership period of the Property from the date settlement on the purchase of the property occurred until settlement on the disposal of the property occurs. Step 4. Calculate the non-main residence days This is the total number of days in your ownership period when the new dwelling was not your main residence. In your case your non-main residence days are from settlement on the purchase of the Property to the date six months prior to the settlement date on the disposal of Property B. This calculation also applies to the portion of the Property land that was not tenanted, that you have used as adjacent land in association with the new dwelling from the date you moved into the new dwelling. The portion of the Property land that had been used with the original dwelling when it was tenanted out only commenced to be used in association with the new property once the original dwelling was demolished. Consequently, it will have a larger number of non-main residence days. Step 5. Apply the partial main residence exemption formula Capital gain x Non-main residence days Total number of days in your ownership period Step 6. Apply the 50% CGT discount Reduce the capital gain amount calculated in step 5 by applying the 50% CGT discount, resulting in the new capital gain amount which will be included in your assessment in the income year in which the Property and the new dwelling are disposed of.