Edited version of your written advice

Authorisation Number: 1051384767170

Date of advice: 14 June 2018

Ruling

Subject: Capital gains tax – main residence – absence choice

Question 1

Did your entitlement to a full main residence exemption on your family home expire at the end of the six year period?

Answer

Yes

Question 2

Is your cost base the market value of your family home the date it became an investment property?

Answer

Yes.

Question 3

Are you entitled to a deduction for the proportion of interest on a line of credit facility used for income producing purposes?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2017

The scheme commenced on

1 July 2016

Relevant facts

You are an Australian resident for taxation purposes.

You purchased a property.

You established this as your family home.

You state that in xxxx someone paid you money which you used to pay out your mortgage on your main residence property. You advise that this payment granted an equitable share in the property.

You advise the share was calculated based on the valuation performed by the bank at that time.

Both you and your partner continued to reside at the property until xxxx at which time you and your partner purchased a business.

You then took a line of credit facility against the property which you used to completely fund the operations of the business.

You rented out the original property from xxxx.

Your Defacto relationship ended in xxxx, however you stayed in the business.

In xxxx you finalised your separation of business arrangements and as had previously agreed you purchased back the equitable interest for the market value of the property at the time. This amount was accessed from your line of credit facility.

You used money from your line of credit facility to purchase properties to generate rental income for yourself.

You have continuously rented the first property since moving out.

You have chosen to continue to treat your original property as your main residence for your entire ownership period.

You sold the original property in 2017.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-130

Income Tax Assessment Act 1997 Section 118-145.

Income Tax Assessment Act 1997 Section 118-185.

Income Tax Assessment Act 1997 Section 118-192.

Reasons for decision

Main residence

To get the full main residence exemption from capital gains tax:

● a dwelling must have been your home for the whole period you owned it

● you must not have used the dwelling to produce assessable income, and

● the land on which the dwelling is situated must be two hectares or less.

You can choose to continue to treat an income producing dwelling as your main residence after it has ceased to be your main residence, however, the maximum period for which it can be treated as your main residence is six years.

If a dwelling ceases to be your main residence more than once during your ownership period, the maximum six year period can apply in relation to each period of absence. All periods of income producing use during all absences, are not aggregated to calculate the six year period.

However, in order to be able to exempt any further periods of income producing use (in addition to the six year maximum for the first absence) the dwelling must again become your main residence after each absence. A minimum period is not specified because whether the dwelling again becomes your main residence is a question of fact.

In your case, you have chosen to continue to treat your family home as your main residence for six years after you ceased living in it. The dwelling was income producing for the six years and subsequent years until you sold the property in xxxx. You did not return to live in the family home prior to its disposal.

Therefore, the full main residence exemption ceased after the six years of rental use of your family home.

Land greater than two hectares

A full main residence exemption can only apply if the dwelling is on land of two hectares or less. However, a partial exemption is available in circumstances where the land is more than two hectares.

In this case as the property was more than two hectares, a partial main residence exemption is available. Therefore, only a portion of the capital gain can be disregarded.

Taxation Determination TD 1999/67 Income tax: capital gains: if your land (including land on which your dwelling is situated) exceeds 2 hectares, can you select which 2 hectares the main residence exemption in Subdivision 118-B applies to and, if so, how do you calculate any capital gain or capital loss you make on the remainder of your land?, provides guidance on how you calculate your gain on land exceeding 2 hectares.

TD 1999/67 at paragraphs 1 to 4 states:

You can apply the main residence exemption to whichever area of land you choose in addition to the land on which your dwelling is situated. If your selected area of land can be separately valued, you calculate your capital gain or capital loss on the remainder of your land by apportioning the capital proceeds and the cost base or reduced cost base (if applicable) on the basis of the valuation. This is relevant if the value of the remainder of the land is of a greater or lesser value than your selected area of land. If your selected area of land cannot be separately valued, your capital gain or loss on the remainder of your land may be calculated by apportioning the capital proceeds and the cost base or reduced cost base (if applicable) on an area basis.

Dwelling first used to produce income

If a main residence is first used to produce income after 20 August 1996, there is a special rule that affects the way you calculate your capital gain or capital loss.

This rule provides that you are taken to have acquired the dwelling at its market value at the time it is first used to produce income if all of the following conditions apply:

● you acquired the dwelling on or after 20 September 1985;

● you first used the dwelling to produce income after 20 August 1996;

● when a CGT event happens in relation to the dwelling, you would only get a partial exemption because the dwelling was used to produce income during the period you owned it; and

● you would have been entitled to a full exemption if the CGT event happened to the dwelling immediately before you first used it to produce income.

In your case, you meet all of the conditions above and as such you are taken to have acquired your family home at its market value on the day you moved out and rented it.

Where the market value of an asset needs to be determined you can either obtain a detailed valuation from a qualified valuer or compute your own valuation based on reasonably objective and supportable data.

How to calculate the partial exemption

Your capital gain or capital loss is worked out under the following partial exemption formula:

When working out your capital gain or capital loss, the first element of your family home's cost base and reduced cost base is its market value on the day it was first used for income producing purposes. Expenditure incurred prior to that date is ignored.

Number of days in your ownership period when the dwelling was not your main residence is the number of days from the end of the six year period until you disposed of the family home.

Total number of days in your ownership period is the number of days from the date when the family home was first used for income producing purposes (when you are now taken to have acquired the family home) until you dispose of it.

An additional calculation would need to be completed from the date you acquired back the ownership interest to the date of disposal. The main residence exemption would not apply to this calculation.

The discount method of calculating your capital gain can be used if:

● You’re an individual

● The CGT event happened to your asset after 21 September 1999

● You acquired the asset at least 12 months before the CGT event

● You did not choose to use the indexation method

You can choose to use the discount method to your total capital gain so you can multiple the amount x 50%.

Deductibility of interest on line of credit

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. However, where a loan relates to private purposes, no deduction is allowed.

Line of credit facilities

Taxation Ruling TR 2000/2 considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities.

The ruling establishes drawing any excess or available funds from the loan is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put.

Where a person uses the redrawn funds for different purposes then the loan account becomes a mixed purpose account. In a mixed purpose loan, the interest must be apportioned between the income producing and non-income producing purposes. The part of the accrued interest attributable to the funds used for private purposes is not deductible.

Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

The apportionment method provided in TR 2000/2 is not the only method that may be used. The onus is on the taxpayer to show that the method they have used is fair and reasonable in their circumstances.

TR 2000/2 provides a method of apportionment (based on monthly balances, even if interest accrues daily) that the ATO considers fair and reasonable. Repayments of principal are generally applied proportionately against the outstanding income-producing and non-income-producing balances, except if borrowed money is recouped (e.g. on sale of an asset purchased with the borrowed money) or a mixed-purpose debt is refinanced. In the case of a redraw facility, it is how the redrawn moneys are used that determines deductibility of interest and not how the original loan was used.

Please ensure you keep accurate records in relation to your loan and method used to calculate your deductible amount.