• Major capital improvements to a dwelling acquired before 20 September 1985

    Attention

    Warning:

    This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

    End of attention

    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 CGT event happens in relation 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 they are made on or after 20 September 1985.

    If the dwelling is your main residence and the improvements are used 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 2 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 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:

    When you dispose of the dwelling, the capital gain or capital loss on the major improvements is calculated 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

    =

    proceeds of sale attributable to improvements

    -

    cost base of improvements

    You can choose to calculate the capital gain made on the improvements using either the indexation or the discount method if:

    • the improvements were made under a contract entered into before 11.45am (by legal time in the ACT) on 21 September 1999
    • the dwelling was sold after that time, and
    • you owned the improvements for at least 12 months.

    If you entered into the contract to make the improvements after 11.45am (by legal time in the ACT) on 21 September 1999 and you owned them for more than 12 months, you can calculate your capital gain using the CGT discount of 50%.

    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.

    Example - Improvement on land acquired before 20 September 1985

    Martin bought a home in 1984. On 1 December 1993, he undertook major capital improvements worth $95,000. He sold the home for $500,000 under a contract that was settled on 1 December 2003. At the date of sale, the indexed cost base of the improvements was $106,590.

    Of the $500,000 he received for the home, $120,000 could be attributed to the improvements. The improvements were used by Martin to produce income from the time they were finished until the time they were sold with the home.

    The 'home first used to produce income' rule does not apply to the improvements because they were first used to produce income before 21 August 1996.

    Test 1

    Is the cost base of the improvements more than 5% of $500,000, that is, $25,000?

    Yes

    Test 2

    Is the cost base of the improvements more than the 2003-04 threshold of $104,377?

    Yes

    (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.

    Martin's capital gain using the indexation method is calculated as follows:

    Amount of proceeds attributable to the improvements

    $120,000

    less cost base of improvements indexed for inflation

    $106,590

    Taxable capital gain

    $13,410

    Martin's capital gain using the discount method (assuming he has no capital losses or capital gains in the 2003-04 income year and does not have any prior year net capital losses) is:

    Amount of proceeds attributable to the improvements

    $120,000

    less cost base of improvements (without indexation)

    $95,000

    Capital gain

    $25,000

    less 50% discount

    $12,500

    Net capital gain

    $12,500

    Martin chooses 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.

    End of example
    Last modified: 04 Mar 2016QC 27527