Private ruling: Capital Gains Tax, Major improvements to pre CGT asset
Date of advice: 19 April 2018
Published: July 2018
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are the improvements on your main residence that you acquired before 20 September 1985 treated as a separate asset that is subject to Capital Gains Tax (CGT)? | A1: Yes | Q2: Can you claim partial main residence exemption on the “separate asset”? | A2: Yes

Relevant facts and circumstances: Your old home (Property A) was acquired pre CGT and was your primary place of residence. You purchased a new home (Property B) and moved into it in xxxx treating it as your new primary place of residence. Settlement date xxxx You did not rent out Property A after you moved out of it. You sold Property A in xxxx, the date of settlement xxxx. Your old home (Property A) had renovations commencing in xxxx totalling $xxxx. The contract date of renovations to your old home (Property A) was xxxxxx, progress payments were made from xxxxx with final payment on xxxx.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 108-70(3) | Income Tax Assessment Act 1997 Section 116-40(2) | Income Tax Assessment Act 1997 Subdivision 118B | Income Tax Assessment Act 1997 Section 118-110(1) | Income Tax Assessment Act 1997 Section 118-130(2) | Income Tax Assessment Act 1997 Section 118-130(3) | Income Tax Assessment Act 1997 Section 118-135 | Income Tax Assessment Act 1997 Section 118-140 | Income Tax Assessment Act 1997 Section 118-140(1) | Income Tax Assessment Act 1997 Section 118-185 and | Income Tax Assessment Act 1997 Section 118-185(2).

Reasons for decision: Detailed Reasoning - Capital Gains Tax: The CGT regime started on 20 September 1985. If property was acquired before this date then any gains or losses from the sale of that property will be disregarded. However, section 108-70(3) of the Income Tax Assessment Act 1997 (ITAA 1997) states that a capital improvement to a CGT asset that was acquired before 20 September 1985 is taken to be a separate CGT asset if its cost base when a CGT event happens in relation to the original asset is: a) More than the improvement threshold for the income year in which the event happened; and b) More than 5% of the capital proceeds from the event. In your case the cost of the improvements will be more than 5% of the capital proceeds from the CGT event in relation to the disposal of the property. The total cost of the renovations xxxx have an indexed value of xxxx and the threshold is $147,582 for the 2017/18 year when the CGT event occurred. Therefore the capital improvements are to be treated as a separate CGT asset that is subject to CGT unless the main residence exemption applies. Note: The cost of the improvements is indexed for the separate asset test. To work out your capital gain you may choose either the indexation method or the discount method whichever method would give you lower capital gain. | Detailed Reasoning - Main residence exemption: Section 118-110 of the ITAA 1997 provides that a capital gain or loss that you make from a CGT event that happens to a dwelling you own is disregarded if certain conditions are met. The conditions are that you must be an individual and the dwelling was your main residence throughout your ownership period and the dwelling did not pass to you through a deceased estate. In your case Property A was sold in xxxx with settlement on xxxx. The property was originally purchased in xxxx, pre CGT, however you carried out major renovations post CGT that are subject to CGT. The improvements are a post CGT asset and can be treated as your main residence. However, as the separate asset was not your main residence for your entire ownership period, you are not entitled to a full main residence exemption. | Detailed Reasoning - Meaning of ownership: Section 118-130(2) of the ITAA 1997 states that for a dwelling that you acquire under contract, you have an ownership interest in it from the time when you obtain legal ownership of it; or if the contract or a related contract gives you a right to occupy it at an earlier time – the earlier time. Section 118-130(3) of the ITAA 1997 states that for a dwelling where you have a contract for the happening of the CGT event, you have an ownership interest in it until your legal ownership interest in the dwelling ends. Section 118-135 of the ITAA 1997 states that a dwelling becomes your main residence from the commencement of your ownership period if you moved into it as soon as practicable after you acquired your ownership interest in it. In your case you moved from property A into your new property B that had a settlement date of xxxx while property A was marketed for sale. Property A’s sale settled in xxxx. | Detailed Reasoning - Changing main residence: Section 118-140(1) of the ITAA 1997 states that if you acquire ownership interest in a dwelling that is to become you main residence and you still have your ownership interest in your existing main residence, 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 ● you did not use the old dwelling to produce assessable income in any part of that 12 months when it was not your main residence, and ● the new dwelling becomes your main residence. In your situation the six month main residence capital gains exemption will apply to the six month period from Property B settlement date xxxx and end on xxxx. | Detailed Reasoning - Partial main residence exemption: Section 118-185 of the ITAA 1997 provides that you apportion the number of days that a dwelling was not your main residence against the number of days in total that you owned it if you are an individual, the dwelling was your main residence for only part of your ownership period and the interest did not pass to you as beneficiary of an estate. The formula is provided in subsection 118-185(2) of the ITAA 1997 and is as follows: CG or CL amount × Non-main residence days Days in your *ownership period As outlined in above Section 118-140(1) of the ITAA 1997 both homes can be treated as your main residence for a 6 month period from the date of settlement of property B, xxxx until xxxx (6 months). Property A settled on xxxx therefore the non-main residence days are calculated from end of 6 months from xxxx to xxxx (48 days). Your total days of ownership of the “property A (separate asset)” will be from the date of the completed renovations e.g. xxxx to the settlement date in xxxx (8683 days). | Detailed Reasoning - Capital Proceeds Apportionment: Section 116-40(2) of the ITAA 1997 states if you receive a payment in connection with a transaction that relates to one CGT event and something else, the capital proceeds from the event are so much of the payment as is reasonably attributable. In your case the CGT event relates to the capital improvements component of property A. You calculate the capital gain or loss on the major improvements by taking away the cost base of the improvements from the proceeds of the sale that are reasonably attributable to the improvements. Proceeds of sale attributable to improvements less Cost base of improvements = CG on major improvements. In calculating the amount of capital proceeds to be attribute to the improvements, you must take whatever steps are appropriate to work out their value. If you make an estimate of this amount, it must be reasonable and you must be able to show how you arrived at the estimated amount. | Detailed Reasoning - Capital Gain calculation – Indexation or Discount method: You can choose to calculate your capital gain made on the improvements using either the indexation or the discount method as you entered into the contract for the improvements prior to 21 September 1999 and sold your home after this time and you owned the improvements for at least 12 months. | Detailed Reasoning - Indexation Method: Amount of proceeds attributable to the improvements $200,000 Less cost base of improvements indexed for inflation $168,500 Taxable capital gain $ 31,150 | Detailed Reasoning - Discount Method: Amount of proceeds attributable to the improvements $200,000 Less cost base of improvements without indexation $150,000 Taxable capital gain $ 50,000 Less 50% discount $ 25,000 Net capital gain $ 25,000 Therefore you would choose the discount method because this gives you a lower capital gain. | Detailed Reasoning - Applying the partial main residence exemption: You now use the capital gain amount to apply the partial exemption $25,000 × 48 days 8683 days | Detailed Reasoning - Total $138 capital gain: If the property title is in two equal shares the capital gain would then be divided in two, giving a $69 capital gain to each individual.