Edited version of private advice

Authorisation Number: 1051961695788

Date of advice: 21 March 2022

Ruling

Subject: CGT - main residence exemption and reduced cost base calculation

Question 1

Can you include the cost of repairs and improvements in your calculation of the reduced cost base?

Answer

Yes, to the extent that you have not already deducted these expenses and cannot deduct them in a prior income year because you are now out of time to amend that year's income tax return.

Question 2

Does a partial main residence exemption apply to the calculation of your capital loss on disposal of your property?

Answer

Yes. Your main residence exemption is reduced to the extent that you have used the property for income producing purposes during your ownership period.

This ruling applies for the following period:

XX June ZZ

The scheme commences on:

XX July 20YY

Relevant facts and circumstances

You purchased a property in October 20UU (the property)

You hold the property in equal shares (i.e. 50% legal ownership each) as joint tenants.

You disposed of the property in October 20YY for more than you paid to purchase it.

You owned the property for AAA weeks.

Your principal residence was the property for BBB weeks.

For the remaining CC weeks, you resided at a different property you owned.

You first earnt income from renting out the property in October 20VV.

In October 20VV, the market value of the property was greater than the amount you received when you sold it.

From 20WW you rented out the property to varying extents as follows:

The downstairs floor area was 50% of the total floor area of the dwelling at the property and completely independent of the upstairs area. Outside areas were shared equally.

You claimed certain deductions for expenses relating to the property in the years it was rented out.

You apportioned expenses that related to the whole of the property on a 50% basis to reflect the proportion of the living area of the home used to produce income.

You have chosen the property as your main residence throughout your ownership period for capital gains tax (CGT) purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 100-45

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-55

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-145

Income Tax Assessment Act 1997 section 118-185

Income Tax Assessment Act 1997 section 118-190

Income Tax Assessment Act 1997 section 118-192

Reasons for decision

Repairs and improvements

Under section 102-20 of Income Tax Assessment Act 1997 (ITAA 1997) you make a capital gain or loss when a CGT event happens to a CGT asset.

When you dispose of your ownership interest in property, CGT event A1 happens, per section 104-10 of the ITAA 1997.

The method statement for calculating a capital gain or loss for a CGT event is provided in section 100-45 of the Income Tax Assessment Act 1997, as follows:

1.    Work out your capital proceeds from the CGT event

2.    Work out the cost base for the CGT asset.

3.    Subtract the cost base from the capital proceeds.

4.    If the proceeds exceed the cost base, the difference is your capital gain.

5.    If not, work out the reduced cost base for the asset.

6.    If the reduced cost base exceeds the capital proceeds, the difference is your capital loss.

7.    If the capital proceeds are less than the cost base but more than the reduced cost base, you have neither a capital gain nor a capital loss.

Relevantly, section 116-20 of the ITAA 1997 states that the capital proceeds from a CGT event are the total of the money you have received and the market value of any other property you have received in respect of the event happening.

When calculating the cost base for a main residence, section 118-192 of the ITAA 1997 holds a special rule that applies if:

•         you would only get a partial main residence exemption for a CGT event happening in relation to your ownership interest in a dwelling because the dwelling was used for the purpose of producing assessable income during your ownership period; and

•         the use occurred for the first time after 7:30pm, by legal time in the Australian Capital Territory, on 20 August 1996; and

•         you would have had a full main residence exemption if the CGT event had happened just before the first time it was used for income producing purposes during your ownership period.

When the above requirements are met, you are taken to have acquired the dwelling at its market value just before the time it was first used to produce income. This impacts on the first element of your cost base or reduced cost base calculation.

You first used the property to produce assessable income in October 20VV and prior to this time would have been entitled to a full main residence exemption. As such, the special rule requires a market valuation of the property immediately before then. You have established that the market value of the property in October 20VV was considerably higher than the amount you eventually sold the property for (the capital proceeds). As such, according to the method statement provided above, you will need to use the reduced cost base to calculate your capital loss for the property.

Sections 110-25 and 110-55 of the ITAA 1997 when read together explain that the reduced cost base of a CGT asset comprises five elements, as follows:

1.    The total of the money you have paid and the market value of any other property you gave in respect of acquiring it.

2.    Incidental costs you incurred, including:

a.    Stamp duty.

b.    Professional fees.

c.     Costs of transfer.

d.    Costs of advertising and marketing.

e.    Valuation and apportionment costs.

f.      Search fees.

g.    Borrowing expenses, such as loan application fees.

3.    Balancing adjustment amount (any amount that is assessable because of a balancing adjustment for the asset or that would be assessable if certain balancing adjustment relief were not available).

4.    Capital expenditure you incurred to increase or preserve the asset's value...

5.    Capital expenditure you incurred to establish preserve or defend your title to the asset...

You cannot include expenditure in the cost base to the extent that costs were deducted, or are still within the time limits to be deducted, in a previous year.

Given all of the above, when calculating your reduced cost base, you can include that part of the cost of repairs and improvements that have not previously been deducted or that may still be deducted in respect of a prior year. Expenses that have been previously deducted will lower your reduced cost base.

Application of the main residence exemption to your capital loss

Section 118-110 of the ITAA 1997 provides that you can ignore a capital gain or loss from a CGT event that happens to your ownership interest in a dwelling that is your main residence. To obtain the full exemption:

•         The dwelling must have been your home the whole period you owned it; and

•         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.

Generally, if you own more than one dwelling during any particular period, only one of them can be your main residence at any one time. You can choose to treat a dwelling as your main residence even when you no longer live in it subject to certain conditions, per section 118-145 of the ITAA 1997.

Where you are not entitled to a full exemption, you may still be able to obtain a partial main residence exemption under section 118-185 of the ITAA 1997. The formula to calculate the reduction to your capital loss from a partial main residence exemption is:

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The 'your capital loss amount' for each individual will be 50% of the whole capital loss for the property because there are two of you with equal shares in the property; calculated as follows:

Your capital loss amount ($) = Capital loss for the property ($) x 50%

Further, section 118-190 of the ITAA 1997 provides that where you have used the property to produce assessable income your exemption will be reduced to the extent that you would have been able to deduct interest, if you had financed the property. That is to say, you must use a fair and reasonable approach to apportion between the use of your property for income producing purposes and your use of the property as your main residence.

You have established that the property was rented out 100% when the whole property was rented out and 50% when the downstairs area only was rented out. As such, your main residence exemption will be further reduced to reflect this income producing use. Building on our initial formula, the formula to calculate the reduction to your main residence exemption would now be:

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