• Major capital improvements to a dwelling

    Introduction

    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.

    Your main residence

    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.

    Other dwellings

    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.

    What is a major capital improvement?

    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
    • 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.

    Calculating your capital gain or capital loss on major improvements

    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

    =

    proceeds of sale attributable to improvements

    cost base of improvements

    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 Working out your capital gain or loss.

    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 $150,000. He sold the home for $500,000 under a contract that was settled on 1 December 2015. At the date of sale, the indexed cost base of the improvements was $168,450.

    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

    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 2015–16 threshold of $143,392?

    Yes

    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

    $200,000

    less cost base of improvements indexed for inflation

    $168,450

    Taxable capital gain

    $31,550

    Discount method

    Martin's capital gain using the discount method (assuming he has no other capital losses or capital gains in the 2015–16 income year and does not have any unapplied net capital losses from earlier years) is:

    Amount of proceeds attributable to the improvements

    $200,000

    less cost base of improvements (without indexation)

    $150,000

    Capital gain

    $50,000

    less 50% discount

    $25,000

    Net capital gain

    $25,000

    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.

    End of example

     

    Example

    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.

    End of example

    See also:

    For help applying this to your own situation, phone 13 28 61.

      Last modified: 21 Jun 2016QC 17194