Edited version of private advice

Authorisation Number: 1051935223147

Date of advice: 17 December 2021

Ruling

Subject: CGT - partial main residence exemption

Question

Will you be eligible for a partial main residence exemption on the disposal of Duplex A?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You purchased a property several years ago (The Property)

You have a 100% ownership interest in The Property.

You lived at The Property from the time of purchase for several years. After several years, you vacated The Property and began to rent it out.

You estimate at the time The Property was first rented out it was worth $XXX,XXX.

You moved back into The Property after another few years. You estimate that at this time The Property was valued at $X, XXX, XXX.

You plan to demolish the dwelling located on The Property and build some duplexes.

You estimate that the duplexes will be completed the following year.

Duplex A will be on one title and Duplex B will be on another title.

You plan to reside in Duplex A and sell Duplex B.

You will retain 100% ownership of Duplex A.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-20

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 section 112-30

Income Tax Assessment Act 1997 section 116-25

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-145

Income Tax Assessment Act 1997 section 118-150

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

Detailed reasoning

Capital gains tax

Capital gains tax (CGT) is a tax that is payable on the disposal of a CGT asset. CGT assets include land and buildings.

CGT event A1 occurs when you dispose of your ownership interest in a CGT asset. For instance, when you sell your property to another party.

A capital gain is made if the amount received (called capital proceeds) from the disposal of the asset exceeds the cost base (the cost of the asset and certain other costs associated with acquiring, holding, and disposing of the asset) of the CGT asset.

Subdivision of land

When a block of land is subdivided, the original land parcel is split into two or more separate assets. You will be taken to have acquired the newly divided block at the same time as the original block. Subdivision itself is not considered to be a CGT event as subdividing does not change ownership of the subdivided block.

The original cost base needs to be apportioned between the new assets in a manner that is reasonable in the circumstances. This may be on an area basis or relative market value basis.

Once the duplexes are built and the land is divided, section 112-25 of the ITAA 1997 provides that each element of the cost base and reduced cost base of the original asset (worked out at the time of the split) must be apportioned in a reasonable way and included in the corresponding element of the cost base and reduced cost base of each new asset.

Partial main residence exemption

Generally, you can ignore a capital gain or capital loss from a CGT event that happens to a dwelling that is your main residence.

If a CGT event happens to a dwelling you acquired on or after 20 September 1985 and that dwelling was not your main residence for the whole time you owned it, you are entitled to a partial exemption.

To obtain a partial main residence exemption, you must have initially established the dwelling as your main residence. Where the dwelling is used to produce income, you can nominate the dwelling as your main residence for up to six years before your full exemption is reduced. The six-year period will start again if you move back into the dwelling and re-establish it as your main residence, before using it for another period of income production.

You calculate your capital gain using the following formula:

Capital gain x Non-main residence days

Total number of days in your ownership period

First use to produce income

Section 118-192 of the ITAA 1997 contains a special rule which applies when the taxpayer loses the entitlement to a full main residence exemption because the dwelling was used for income-producing purposes for the first time. Where the following conditions are satisfied, the taxpayer is taken to have acquired the dwelling or the taxpayer ' s ownership interest in the dwelling immediately before the first time it was used for income producing purposes for its market value at that time.

The first use to produce income rule is not relevant here, as CGT event C1 occurs prior to disposal and the dwelling used to produce income was destroyed.

Demolishing a dwelling and moving into a new dwelling

When you demolish a dwelling, you may choose to nominate the land on which it is located as your main residence, provided:

•         You move into the new dwelling as soon as practicable

•         You do not nominate another dwelling as your main residence during this period.

You have the shorter of 4 years from the demolition of the dwelling until moving into the new dwelling or the time since your ownership interest commenced to exercise this choice.

C1 event

CGT event C1 happens on destruction of the dwelling. In accordance with the CGT rules, as no capital proceeds were received for the destruction of the dwelling, the entire cost base is allocated to the land.

Partial main residence exemption

Based on your situation, you will be eligible for a partial main residence exemption on the disposal of Duplex A.

You will nominate Duplex A as your main residence when you dispose of it and exercise the absence choice in the relevant income year return.

As you have advised you will nominate Duplex A as your main residence, you can include the days following the original dwelling being demolished and Duplex A being built as main residence days.

You will be required to calculate your capital gain based on the number of non- main residence days in your ownership period.

Cost base

As CGT event C1 will occur on demolition of the original dwelling and no capital proceeds will be received, there will be no capital gain or loss at the time of CGT event C1.

To establish the cost base of Duplex A and Duplex B, you will need to apportion the costs in a manner that is reasonable in the circumstances. This may be on an area basis or cost basis.

As the capital proceeds from the demolition will be nil and the cost base attributed to the dwelling will be nil, you will not make a capital gain or loss when the dwelling is demolished.

Costs of improvement to the assets, here the subdivided blocks of land, including the building of the new dwellings, can be added to the fourth element of the cost base for the Duplexes. Demolition costs may also be added to the fourth element where they can be shown to improve or preserve the value of the assets.