When is the sale of a taxpayer’s home subject to CGT?

It is commonly understood that the sale of a taxpayer’s private home is exempt from CGT … but this is not always the case. So what are the circumstances in which the sale of a property in which the taxpayer had lived may give rise to a tax liability?

The main residence exemption

The main residence exemption (MRE) in Subdiv 118-B of the ITAA 1997 provides a full or partial exemption in respect of a capital gain or loss that a taxpayer makes from a CGT event (e.g. a disposal) happening to their ‘dwelling’.

The MRE only applies to an individual taxpayer.

A ‘dwelling’ is defined as including a unit of accommodation that is:

• a building or is contained in a building, and consists wholly or mainly of residential accommodation, or
• a caravan, houseboat or other mobile home.

The dwelling also includes any land immediately under the unit of accommodation.

If the taxpayer has lived in their dwelling for the entire period of ownership and has not used the property for income-producing purposes then the taxpayer will be eligible for a full tax exemption.

However the exemption is reduced in some circumstances. The calculation of a partially taxable gain may also be adjusted.

When a partial exemption may apply

Using the dwelling for income-producing purposes

A partial exemption applies if the dwelling was used for the purpose of producing assessable income during all or part of the period of the taxpayer’s ownership.

This may include:

• using part of the property for a home-based business, or renting out a room, while the taxpayer is living in the property
• using the property for short-term rental (e.g. Airbnb) during periods when the taxpayer is away on holidays
• renting out the property when the taxpayer has moved somewhere else.

The reduction in the MRE takes into account the amount of time that the dwelling was used for income-producing purposes as well as the proportion of the property (which may be measured in different ways, e.g. by area) which was used for those purposes.

When a dwelling is not the taxpayer’s main residence

The extent to which the taxpayer can access the MRE depends on the proportion of their period of ownership in which the dwelling is the taxpayer’s ‘main residence’.

The tax legislation does not define ‘main residence’ but the ATO will consider a dwelling to be the taxpayer’s main residence if:

• the taxpayer and their family live in it
• the taxpayer’s personal belongings are in it
• it is the address the taxpayer’s mail is delivered to
• it is the taxpayer’s address on the electoral roll
• services such as gas and power are connected.

The length of time the taxpayer stays in the dwelling and whether they intend to occupy it as their home may also be relevant.

A taxpayer’s home will be their main residence from the start of their ownership period, provided they move in ‘as soon as practicable’.

If there is a delay moving in because of illness or other unforeseen circumstances — the dwelling will still qualify as a main residence, provided the taxpayer moves in as soon s the cause of the delay is remove (e.g. when they recover from the illness).

If the taxpayer cannot move in because the property is being rented to someone else — the property does not become the taxpayer’s main residence until they move in.

There are specific situations in which a taxpayer may treat a dwelling as their main residence for a period even if they were not living there during that period — see below for a list — so the taxpayer may be able to access a full exemption, or a greater partial exemption., than would otherwise be the case.

Adjacent land over two hectares

Generally the maximum area of land adjacent to the dwelling covered by the MRE rules is two hectares, less the area of the land immediately under the dwelling. Land outside this area is not eligible for an exemption even if it is wholly used for private purposes.

When the dwelling is treated as the taxpayer’s main residence even if they are not living there

The MRE legislation contains special rules under which a taxpayer may choose to treat a dwelling as their main residence for a certain period of time even if they are not living in it during that time:

• if they move out of the dwelling and use it for income-producing purposes — for a maximum period of six years
• if they move out of the dwelling and does not use it for income-producing purposes — indefinitely
• where the dwelling is subject to a compulsory acquisition, or loss or destruction — up to four years before acquiring a replacement dwelling
• if they move house — for up to six months where the taxpayer has not disposed of the old dwelling
• where the taxpayer’s spouse resides in a different dwelling — the spouses may choose to nominate the same or different dwellings as their main residence
• where the taxpayer’s dependent child resides in a different dwelling — the taxpayer must choose one of the dwellings as the main residence of both
• where the taxpayer acquired their interest in a dwelling in a marriage breakdown — the taxpayer inherits the former owner (former spouse)’s main residence history
• inherited dwellings — the taxpayer may be eligible for the full or partial MRE even if they have never lived in the inherited property.

In most (but not all) cases, where the taxpayer treats a particular dwelling as their main residence during a period of time, they cannot also treat another dwelling as a main residence during that same period of time.

Adjustments to proceeds and cost base

If the MRE applies only partially or not at all, a taxable capital gain will need to be calculated. There are some situations in which the proceeds or the cost base requires adjustment.

Capital proceeds

Generally, the capital proceeds from a CGT event are the sum of:

• the money the taxpayer has received, or is entitled to receive
• the market value of any other property the taxpayer has received, or is entitled to receive.

A taxpayer may wish to transfer their interest in their family home to an adult child for either no proceeds, or less than market value proceeds in a non-arm’s length arrangement. A market value substitute rule ensures that in calculating the capital gain or loss, the capital proceeds are taken to be equal to the market value of the dwelling at the time of the disposal.

Cost base

The cost base of the dwelling comprises five elements:

1. The total of the money the taxpayer paid, or is required to pay, and the market value of any other property the taxpayer gave, or is required to give.
2. Incidental costs (e.g. stamp duty, legal fees).
3. Costs of ownership (e.g. interest, rates and land tax, repairs and insurance).
4. Capital expenditure incurred to increase or preserve the dwelling’s value.
5. Capital expenditure incurred to establish, preserve or defend the taxpayer’s title to the dwelling.

Certain amounts are excluded from being included in cost base, including amounts which the taxpayer could have deducted (e.g. capital works deductions during a period when the property was rented out).

The first element of the cost base and reduced cost base of the dwelling is its market value at the time of acquisition if:

• the taxpayer did not incur expenditure to acquire it
• some or all of the expenditure incurred to acquire it cannot be valued, or
• it was acquired in a non-arm’s length transaction.

Some or all of the above may apply where for example the taxpayer had acquired the property from their parents at non-arm’s length terms.

Where the dwelling has been used for income-producing purposes, the total cost base is treated as the market value of the dwelling at the first time it was used for those purposes.

Where the taxpayer acquired the dwelling, or a part interest in the dwelling, in a marriage breakdown that was subject to the marriage breakdown CGT roll-over, the first element of the cost base is equal to the total cost base in the hands of the transferor spouse.

Where the property was inherited through a deceased estate:

• a post-CGT dwelling that was the deceased’s main residence and was not being used for income-producing purposes — the market value on the day of death
• any other post-CGT dwelling — the cost base in the hands of the deceased on the day of death
• a pre-CGT dwelling — the market value on the day of death.

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