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Subject: capital gains tax - main residence - first used to produce income

Question: Will the market value of your dwelling on the date you commenced renting it out be the first element of your cost base or reduced cost base of your dwelling?

Answer: Yes

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

You jointly purchased a dwelling after 20 September 1985 with your spouse, Dwelling A.

You moved into the dwelling when settlement occurred and the dwelling was your main residence.

You and your spouse purchased another dwelling, Dwelling B.

You have moved into Dwelling B and commenced to rent out Dwelling A

Reasons for decision

Main residence exemption

Generally, you can ignore a capital gain or loss you make on the disposal of a dwelling that was your main residence when the following conditions have been met under section 118-110 of the Income Tax Assessment Act 1997 (ITAA 1997):

· The dwelling must have been your main residence for the whole period you owned it;

· You must not have used the dwelling to produce assessable income; and

· Any land on which the dwelling is situated must be 2 hectares or less.

If you own more than one dwelling during a particular period, only one of them can be your main residence at any one time.

Home first used to produce income

If you start using your main residence to produce income for the first time after 20 August 1996, a special rule affects the way you calculate your capital gain or capital loss under section 118-192 of the ITAA 1997.

In this case, you are taken to have acquired your home at its market value at the time it is first used to produce income if all of the following apply:

· You acquired your dwelling on or after 20 September 1985;

· You first used the dwelling to produce income after 20 August 1996;

· When a capital gains tax (CGT) event occurs, you would only obtain a part exemption because your dwelling was used to produce assessable income during the period you owned it; and

· You would be entitled to a full exemption if the CGT event happened to your dwelling immediately before you first used it to produce income.

If all of the above conditions apply, you must work out your capital gain or capital loss using the market value of the dwelling at the time you first used it to produce income. You do not have a choice.

Section 118-192 of the ITAA 1997 was introduced to reduce compliance and record-keeping costs for taxpayers. However, in some cases the rule may disadvantage a taxpayer (for example if the value of the property increases more rapidly after income producing use). Also costs incurred to enable the dwelling to be used to derive assessable income are not able to be included in the cost base and may not be reflected in the market value. Likewise costs of owning the asset, such as mortgage interest, incurred before the time of first income use can not be included in the cost base under this rule.

Absence choice

In some cases, you can choose to treat a dwelling as your main residence even though you no longer live in it under section 118-145 of the ITAA 1997.

The absence provision allows a dwelling that has qualified as the taxpayer's main residence to continue to be treated as the taxpayer's main residence during a period of absence from the dwelling.

Where the concession is chosen, a dwelling can be treated as the taxpayer's main residence for up to six years of absence when the dwelling is being used to produce assessable income e.g. being rented out.

Once the absence choice has been made, no other dwelling can be treated as your main residence.

Section 118-192 of the ITAA 1997 will not apply where a taxpayer has made the choice under section 118-145 of the ITAA 1997 to treat a dwelling as their main residence during a period of absence in which they also use the dwelling for an income producing purpose and the income producing use does not exceed 6 years. By using the absence concession, the taxpayer will be entitled to a full main residence exemption and condition 3 for the application of section 118-192 of the ITAA 1997 will not be satisfied.

Application to your case

In your case, you and your spouse acquired a dwelling after 20 September 1985, Dwelling A. You moved into the dwelling after settlement occurred and it was your main residence.

You acquired another dwelling, Dwelling B, and moved into it. This dwelling is your main residence for CGT purposes.

You will commence renting out Dwelling A after you have relocated to Dwelling B.

As mentioned above, if you own more than one dwelling during a particular period, only one of them can be your main residence at any one time. In this case, you are not making the absence choice in relation to Dwelling A and Dwelling B will be your main residence from the date you move into it.

Therefore, as all of the conditions listed above for the application of the special rule for first use to produce income have been met in your circumstances, you are taken to have acquired Dwelling A for its market value on the date you first commence renting it out. This is not a choice. The market value will be the first element of the cost base or reduced cost base of Dwelling A.

When working out the market value of Dwelling A, you can choose to:

· Obtain a valuation from a professional valuer, or

· Work out the market value yourself using reasonably objective and supportable data - such as the price paid for very similar property that was sold at the same time in the same location.

We have enclosed the fact sheet Market valuation for tax purposes to assist you in calculating the market value of Dwelling A when you start renting it out. Pages 7 through to 9 provide the methodologies the Commissioner accepts when valuing real property.

Please note, the Commissioner can review any valuation of real property and the methodology used to determine that amount.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-140

Income Tax Assessment Act 1997 Section 118-145

Income Tax Assessment Act 1997 Section 118-190

Income Tax Assessment Act 1997 Section 118-192

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