If you acquired a dwelling before 20 September 1985 and you make major capital improvements after that date, part of any capital gain you make when a capital gains tax (CGT) event happens to the dwelling could be taxable. Even though you acquired the dwelling before CGT started, major capital improvements are considered to be separate CGT assets from the original asset and may therefore be subject to CGT in their own right if you made them on or after 20 September 1985.
If the dwelling is your main residence and you use the improvements as part of your home, they are still exempt. This includes improvements on land adjacent to the dwelling (for example, installing a swimming pool) if the total land, including the land on which the home stands, is two hectares or less.
However, if the dwelling is not your main residence or you used the improvements to produce income for any period, the part of any gain that is attributable to the improvements for that period is taxable.
A capital improvement to an existing structure, such as a renovation to your house, is taken to be major if its original cost (indexed for inflation if the improvements were made under a contract entered into before 11.45am - by legal time in the ACT - on 21 September 1999) is:
- more than 5% of the amount you receive when you dispose of the dwelling, and
- greater than the improvement threshold - which increases every year to take account of inflation. The improvement thresholds are listed in Separate assets for CGT purposes.
When you dispose of the dwelling, you calculate the capital gain or capital 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:
Capital gain on major improvements
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=
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proceeds of sale attributable to improvements
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-
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cost base of improvements
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In calculating the amount of capital proceeds to be attributed 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.
The method you can use for the calculation depends on the date you entered into the contract for the improvements: see Introduction to capital gains tax.
Example
Improvements to a dwelling acquired before 20 September 1985
Martin bought a home in 1984. On 1 December 1993, he undertook major renovations to his home, costing $120,000. He sold the home for $500,000 under a contract that was settled on 1 December 2011. At the date of sale, the indexed cost base of the improvements was $134,640.
Of the $500,000 he received for the home, $200,000 could be attributed to the improvements. Martin used the improvements to produce income from the time they were finished until the time he sold them with the home.
The home first used to produce income rule outlined in Using your home to produce income does not apply to the improvements because they were first used to produce income before 21 August 1996.
Test 1
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Is the cost base of the improvements more than 5% of $500,000 - that is, $25,000?
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Yes
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Test 2
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Is the cost base of the improvements more than the 2011-12 threshold of $130,418?
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Yes
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Note: Because the improvements were made under a contract entered into before 11.45am (by legal time in the ACT) on 21 September 1999, the indexed cost base is used for the purpose of these tests.
As the answer to both questions is Yes and the improvements were used to produce income, the capital gain on the improvements is taxable.
As Martin acquired the improvements before 11.45am (by legal time in the ACT) on 21 September 1999 and sold the home after that time, and had held the improvements for at least 12 months, he could use either the indexation method or the discount method to calculate his capital gain on the improvements.
Indexation method
Martin calculates his capital gain using the indexation method as follows:
Amount of proceeds attributable to the improvements
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$200,000
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less cost base of improvements indexed for inflation
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$134,640
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Taxable capital gain
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$65,360
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Discount method
Martin's capital gain using the discount method (assuming he has no other capital losses or capital gains in the 2011-12 income year and does not have any unapplied net capital losses from earlier years) is:
Amount of proceeds attributable to the improvements
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$200,000
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less cost base of improvements (without indexation)
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$120,000
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Capital gain
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$80,000
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less 50% discount
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$40,000
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Net capital gain
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$40,000
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Therefore, Martin would choose the discount method because this gives him a lower capital gain.
Note:
If the improvements had been used as part of Martin's main residence, this gain would be exempt. However, if the home (including the improvements) had been rented out for one-third of the period, one-third of the capital gain made on the improvements would have been taxable.
If construction of the improvements started after 13 May 1997 and they were used to produce income, Martin would also reduce the cost base by the amount of any capital works deductions he claimed or can claim. If Martin makes a capital loss, the reduced cost base of the improvements is reduced by the amount of any capital works deductions, irrespective of when construction started.
Last Modified: Thursday, 28 June 2012