Edited version of private ruling

Authorisation Number: 1011723399378

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Ruling

Subject: Capital gains tax and Main residence exemption

Question

Will you pay capital gains tax on the sale of your property?

Answer: Yes.

This ruling applies for the following period

Income year ended 30 June 2011

Relevant facts

Before 20 September 1985 you and your spouse purchased a property (the property).

The property was your main residence.

After September 1985, you and your spouse divorced and your spouse signed over their half in the property to you.

In exchange for this share in the property you paid your spouse a sum of money and transferred ownership of a car.

The transfer of your spouse's ownership interest in the property was part of informal settlement and not at the direction of a court order.

You and your children lived in the house until you had to relocate to another town for work.

You have rented out the property on and off. However, for many of these years, a family member did reside in the property.

The period of time that you were absent from the property and renting it out exceeded six years.

You have always declared any rental income.

Tenants damaged the house and restoration costs amounted to a significant amount. You claimed this amount as a deduction.

You resided in accommodation supplied by your employer until you purchased a house in another town.

You will sell the property this year.

You expect to make a capital gain.

Reasons for decision

Summary

When you dispose of the property, you expect to make a capital gain. As the property was not your main residence for your entire ownership period, you will be required to pay capital gains tax.

Detailed Reasoning

You have two half ownership interests in the property. One of these interests (Ownership Interest A) was acquired before 20 September 1985 and is not subject to capital gains tax (CGT). You acquired a second interest in the property (Ownership Interest B) as part of your divorce settlement after September 1985 and this interest will be subject to CGT.

Main Residence Exemption

Once a property has been established as your main residence, you can choose to continue to treat that dwelling as your main residence during periods of absence.

When the property is left vacant you may continue to treat the dwelling as your main residence for an indefinite period. Where the property is rented, the maximum period that you may continue to treat the dwelling as your main residence is six years. You are entitled to another maximum period of six years each time the dwelling again becomes and ceases to be your main residence. The Commissioner does not have the discretion to extend the 6 year period.

In your situation, the property was not your main residence for the entire ownership period and as such you will not obtain a full exemption. Even allowing for you to make a choice during your period of absence from the property to continue treating the property as your main residence, the period of time that you were absent from the property and renting it out exceeds the permitted six years.

Consequently, when you dispose of the property, ownership interest B will be subject to CGT and you will have to calculate your capital gain.

When a taxpayer is not fully exempt from CGT, they may be partially exempt if the property was their main residence during part of the period they owned it.

In your circumstance, a partial exemption is permitted as the property was your main residence for part of your ownership period.

The exemption is calculated on a time basis, with the capital gain made being reduced proportionally. The capital gain is reduced according to the number of days the property was not used or not treated as your main residence as a proportion of the total ownership period. This is expressed in the formula below:

Non main residence days

Capital Gain X  --------------------------------------------

Days in your ownership period

Calculating your capital gain

A capital gain will be realised where the capital proceeds are greater than the cost base and a capital loss will be realised where the reduced cost base is greater than the capital proceeds.

The capital proceeds is the amount of money that you receive on the sale of the property.

The cost base of a CGT asset has five elements. Amounts that are incurred in gaining or producing your assessable income are deductible and are excluded from an assets cost base.

The first element of the cost base is the acquisition cost. This includes the money paid, or required to be paid, in respect of acquiring the CGT asset.

In the event that a taxpayer does not pay anything to acquire a CGT asset or if they do not deal at arm's length with the previous owner in acquiring the asset, they substitute the first element of the cost base with the market value of the asset (the market value substitution rule).

In your situation, you acquired Ownership Interest B as part of informal agreement with your spouse and did not deal at arm's length with them, so in accordance with the market value substitution rule, you are taken to have acquired this interest at market value.

The second element is the incidental costs incurred in acquiring a CGT asset or in relation to a CGT event. Incidental costs can include the following:

· remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser, including costs incurred after the time of a CGT event, eg solicitors fees and agents commission in relation to the sale of real estate that are incurred after the exchange of contracts

· costs of the transfer

· stamp duty or other similar duty

· in relation to the acquisition of a CGT asset, the costs of advertising to find a seller and in relation to a CGT event, the costs of advertising to find a buyer, and

· costs relating to the making of any valuation or apportionment for the purposes of calculating your capital gain or capital loss.

You do not include costs if you have claimed a tax deduction for them.

The third element is the non-capital costs of ownership of an asset. A non-capital cost of ownership of an asset is any expenditure in connection with the continuing ownership of the asset. These costs include interest on money borrowed to acquire an asset, costs of maintaining, repairing and insuring an asset, rates and land tax, interest on money borrowed to refinance the money borrowed to acquire an asset, and interest on any money borrowed to finance capital expenditure incurred to increase an assets value.

However, you do not include such costs if you acquired the asset before the 21 August 1991. As you acquired Ownership Interest B prior to this date, you cannot include any third element costs in your cost base.

The fourth element is capital expenditure incurred to increase the value of the CGT asset. This must be reflected in the enhanced value of the asset at the time of the CGT event.

The fifth element is capital expenditure incurred to establish, preserve or defend the taxpayers title to the asset.

In this situation, you will expect to make a capital gain.

Choosing frozen indexation or the CGT discount

As you owned the property for more than 12 months from the date of acquisition (date contracts exchanged) and acquired the property before 21 September 1999 you are eligible to choose either the fifty percent discount method or the indexation method to calculate your capital gain.

You will need to work out your capital gain using each option and you can then choose which brings about the best result in your particular circumstances.

Discount method

You can use the discount method to calculate your capital gain if:

· you are an individual, a trust or a complying superannuation entity

· a CGT event happens to an asset you own

· the CGT event happened after 11:45am (by legal time in the ACT) on 21 September 1999

· you acquired the asset at least 12 months before the CGT event, and

· you did not choose to use the indexation method.

Under the discount method you reduce your capital gain by the discount percentage. For individuals, the discount percentage is 50%. However, you can reduce the capital gain only after you have applied all the capital losses for the year and any unapplied net capital losses from earlier years.

Indexation

If an asset is acquired before 11.45 am on 21 September 1999 you are able to index the cost base to take into account any inflationary changes.

When the CGT event happens after 11.45 a.m. on 21 September 1999 in relation to an asset acquired before that time, you may choose to claim indexation of the cost base in calculating the capital gain. Indexation is frozen as at 30^th September 1999.

If the CGT event happens after 11.45 am on 21^st September 1999:

Indexation = CPI figure for quarter ending 30/09/1999 (123.4) .

Factor CPI figure for quarter in which expenditure was incurred

For more information calculating your capital gain using either Indexation or the discount method please refer to "The capital gain or capital loss worksheet" at www.ato.gov.au.