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 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 make 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 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 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 a certain threshold. The threshold increases every income year to take account of inflation. Improvement thresholds for 1985–86 to 2010–11 are shown in table 1.
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
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 83: Improvement 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 2010. 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 does not apply to the improvements because they were first used to produce income before 21 August 1996.
The cost base of the improvements is more than 5% of the $500,000 capital proceeds (that is, $25,000) and more than the 2010–11 threshold of $126,619. Therefore, because the improvements were used to produce income, the capital gain on the improvements is taxable. (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 can be used.)
As Martin acquired the improvements before 11.45am (by legal time in the ACT) on 21 September 1999 and sold the home after he 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 calculates his capital gain using the indexation method as follows:
Amount of proceeds attributable to the improvements
less cost base of improvements indexed for inflation
Taxable capital gain
Martin’s capital gain using the discount method (assuming he has no capital losses or other capital gains in the 2010–11 income year and does not have any unapplied net capital losses from earlier years) is:
Amount of proceeds attributable to the improvements
less cost base of improvements (without indexation)
less 50% discount
Net capital gain
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.
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 (see Cost base adjustments for capital works deductions). 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
Buildings or structures constructed on land acquired before 20 September 1985
Buildings or structures constructed on or after 20 September 1985 on land acquired before that date are also considered to be separate CGT assets from the original land. The major capital improvement threshold and 5% of capital proceeds rules do not apply to them. Therefore, they may be subject to CGT if you use them other than as your main residence.