Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.
Chapter 2.12 - Main residence exemption
Overview
This segment covers the rules in Subdivision 118-B which allow an exemption if a CGT event happens concerning a main residence.
Part A summarises these rules.
Part B explains the changes proposed to the 1936 Act.
Part C explains why some provisions of the 1936 Act have not been rewritten.
A. Summary of the new law
Subdivision 118-B: Main residence exemption
Subdivision 118-B determines the extent to which any capital gain or loss is ignored when a CGT event happens to your dwelling.
Any such capital gain or capital loss will be fully exempt if:
- •
- the dwelling was your main residence throughout your ownership; and
- •
- it was not used for any income producing purpose.
[section 118-110]
A dwelling is any building, or part of a building, that consists mainly of residential accommodation and the land it is built on. It includes a caravan, houseboat or other mobile home. [section 118-115]
The main residence exemption extends to adjacent land that has been used primarily for private or domestic purposes with the dwelling. The maximum area of land that qualifies for exemption is two hectares.
[section 118-120]
The ownership period is the period after 19 September 1985 during which the person concerned had an ownership interest in the dwelling or land on which the dwelling is later built. [section 118-125]
You own a dwelling if you have:
- a legal or equitable interest in the land on which the dwelling is built; or
- a licence or right to occupy it.
There are special rules covering a flat or home unit, and when ownership of a dwelling is acquired under a contract. [section 118-130]
Rules that may extend the exemption
For individuals who acquire a new dwelling while retaining their old dwelling, their main residence is the one that they live in. However, they can treat both dwellings as their main residence for up to six months provided:
- the old dwelling was their main residence for a continuous period of at least three months in the previous twelve months; and
- during that twelve month period it was not used for the purpose of producing assessable income while it was not their main residence. [section 118-140]
Absences from an individuals main residence
If a dwelling ceases to be your main residence, you may continue to treat it as your main residence in some circumstances.
If part of the dwelling that was your main residence is used for the purpose of producing assessable income, the maximum period that it can continue to be treated as the main residence is six years.
If the dwelling later becomes your main residence again, the six year rule restarts. [section 118-145]
Building, repairing or renovating a dwelling
Persons who build, repair or renovate a dwelling on land that they already own may be able to treat the land as their main residence for up to four years before taking up residence. No other dwelling can be treated as their main residence during this time. [section 118-150]
Special rules apply where the person dies after entering into contracts for the construction work. [section 118-155]
Accidental destruction of dwelling
The main residence exemption applies if a dwelling is accidentally destroyed (eg. by a bushfire) and the land is disposed of without another dwelling being built on it. [section 118-160]
Rules that may limit the exemption
Separate CGT event happens to adjacent land or other structures
The exemption is affected if a separate CGT event happens to land adjacent to a dwelling or to other structures such as a garage or storeroom. [section 118-165]
Spouse or dependent child having different main residences
Generally, if an individual lives in one dwelling and their spouse or dependent child lives in another, only one of the dwellings can be nominated as the main residence. Special rules apply if spouses nominate different main residences for the same period. [sections 118-170 and 118-175]
Acquisition of dwelling from company or trust on marriage breakdown
When a dwelling is transferred to an individual from a company or trustee under a court order resulting from a marriage breakdown, the individual is treated as having owned the dwelling while it was owned by the company or trustee. However, the dwelling is not treated as the individuals main residence during that period. [section 118-180]
Dwelling used for the purpose of producing assessable income
The exemption may be reduced if the dwelling is used for the purpose of producing assessable income. [section 118-190]
Market value for first income producing use
Special rules substitute a market value cost base the first time a main residence is used for income producing purposes. [section 118-192]
Dwellings acquired from deceased estates
Dwelling acquired from a deceased estate
Any capital gain or loss on a dwelling acquired by an individual as a beneficiary of a deceased estate or by a trustee of a deceased estate is fully exempt if:
- (a)
- the dwelling was the deceased's main residence just before the deceased's death or it was pre-CGT property of the deceased; and
- (b)
- the dwelling was disposed of within two years of the deceaseds death or it was, from the time of the deceaseds death until the disposal, the main residence of:
- the deceased's spouse;
- an individual who had a right to occupy the dwelling under the will; or
- a beneficiary.
[section 118-195]
Partial exemption for deceased estate dwellings
If the gain or loss is not fully exempt, any partial exemption is calculated using a formula. [section 118-200]
Special rules apply if the deceased acquired the dwelling as a beneficiary in or as trustee of a deceased estate. [section 118-205]
Trustee acquiring dwelling under will
If a trustee of a deceased estate acting under a will acquires a dwelling for occupation by an individual, roll-over or a full or partial exemption may be available if a CGT event happens affecting that dwelling. [section 118-210]
B. Discussion of changes
Section 118-100 What this Subdivision is about
Section 118-105 Map of this Subdivision
These proposed sections are guide material and will give a logically organised overview of the main residence exemption. They assist taxpayers to identify, and find their way to, provisions which apply to their situation.
Adopt the term main residence .
The 1936 Act uses the term sole or principal residence. The new term is shorter and more apt. The change does not affect the operation of the provisions.
Section 118-115 Meaning of dwelling
Clarify the meaning of dwelling.
The rewritten provisions make clear that references to a dwelling do not include land adjacent to the building but do include land beneath the building.
Section 118-120 Extension to adjacent land
Specify that adjacent land qualifies for exemption if it is used primarily for private or domestic purposes in association with the dwelling throughout the ownership, not merely at the time of disposal.
Under the 1936 Act, the exemption is expressed in the context of land used for private purposes in association with the dwelling at the time of disposal . The administrative practice has been to look at how the land has been used over the whole ownership period. This is consistent with the rules for exemption of the building itself.
Section 118-130 Meaning of ownership interest in land or a dwelling
The term ownership interest is defined.
This term is used to denote the expanded meaning of ownership under subsections 160ZZQ(1AA), (1AB) and (2) of the 1936 Act.
Section 118-135 Moving into a dwelling
Extend the main residence exemption to take account of the time needed to move into a dwelling, ie. from acquisition until it is first practicable for the individual to move into the dwelling that becomes your main residence.
The rewritten provision takes account of situations where, for example, there is a delay in moving in because of illness or other reasonable cause.
The exemption does not extend to cases where an individual is unable to move into the dwelling because it is being rented out. However, it would cover a period after the end of the tenancy if the owner could not take up residence immediately because of the nature of repairs required to the dwelling.
Section 118-140 Changing main residences
Extend the period during which a taxpayer can have concurrent exemptions for two dwellings from three months to six months.
Under the 1936 Act, if a person moves into a new dwelling before disposing of their old dwelling, the exemption can be claimed for both as main residences for up to three months. The extension allows more time for a sale.
The 1936 Act in some cases allows an individual to continue to treat their dwelling as their main residence after they have moved out. If the dwelling is used for the purpose of producing assessable income, this is limited to six years.
Provide that, if a dwelling is used to produce assessable income, the maximumperiod for it to be treated as a main residence while so used is six years. The rule does not specify when this period commences or ends.
Under the 1936 Act, if a dwelling ceases to be a main residence, it can continue to be treated as one by election. If it is not used to produce assessable income, this can continue indefinitely. If it is used to produce assessable income, a six year limit applies commencing when the dwelling begins to be so used. This can give an anomalous result when, during an absence, there is also a period when the dwelling is vacant or otherwise not used to produce assessable income.
The following examples illustrate this:
Example 1
Clare ceases to use her post-CGT dwelling as her main residence and leaves it vacant for four years, rents it out for a further six years, then sells it.
Clare is entitled to an exemption for the full ten years. This is because under the six year absence rule the period commences from the time the dwelling starts to be used to produce assessable income.
Example 2
Elizabeth ceases to use her post-CGT dwelling as her main residence, rents it out for six years and leaves it vacant for a further four years, then sells it.
Elizabeth is entitled to an exemption for the first six years only. Again, this is because the six year period commences from the time the dwelling starts to be used to produce assessable income.
Under the rewritten section, both Clare and Elizabeth will be entitled to an exemption for ten years. This is because the rewritten rule does not specify when the six year period commences or ends. The rule will simply provide that, if the dwelling is used to produce assessable income, the maximum period that it can continue to be treated as a main residence while it is so used is six years.
1. Relationship with section 118-140 (Changing main residences)
Where a dwelling is used to produce assessable income during an absence, and the individual chooses to treat the dwelling as their main residence during the absence, no other dwelling can be treated as the individuals main residence for the period, with one exception.
An individual will have a choice under this section and proposed section 118-140, to claim exemption for up to six months for two residences while moving from one main residence to another. The relationship between these choices is clearly stated in subsection 118-145(4).
2. Six year limitation - more than one absence
If a dwelling ceases to be an individuals main residence more than once during the ownership period, the maximum six year period of income producing use can apply to each period of absence.
A person need not choose whether to treat the dwelling as their main residence at the time of the absence. The choice only needs to be made on disposal of the dwelling.
3. Aggregation of non-continuous income producing use where there is one period of absence
The six year period need not be continuous. If there are intermittent periods of income producing use during a period of absence, those periods are aggregated to see whether the six year limitation has been exceeded.
Example
Lindy ceases to use her post-CGT dwelling as her main residence and rents it out for five years. She then leaves it vacant for one year, rents it out for a further three years, then sells it.
As there has only been one period of absence, Lindy chooses to continue to treat the dwelling as her main residence until the property has been used to produce income for six years. The exemption covers the first five years of rental use, the period when the dwelling was vacant, and a further one year of rental use. For the remaining two years until sale, the exemption is not available.
Section 118-150 If you build, repair or renovate a dwelling
Provide that the exemption covers the construction period when a dwelling is constructed on land that had an existing dwelling on it regardless of whether the existing dwelling is demolished.
The 1936 Act does not allow the exemption to include the time taken to build a dwelling if there was another dwelling on the land when it was acquired, unless the initial dwelling is demolished. Individuals will now be able to claim the construction period exemption whether or not the initial building is demolished.
Provide that the exemption covers up to four years before the dwelling becomes an individuals main residence, including the period from completion to occupancy.
Under the 1936 Act the four year limit does not always cover from when the building is completed until it is occupied.
Section 118-160 Destruction of dwelling and sale of land
Provide that a person can continue to apply the main residence exemption to a disposal of vacant land where the dwelling that was on it is accidentally destroyed.
Under the 1936 Act, an individual loses the exemption if:
- •
- their main residence is destroyed; and
- •
- the vacant land on which it stood is disposed of.
Under the rewritten law, the individual is able to apply the main residence exemption rules as if the residence was not destroyed until the time of disposal of the land.
This applies, for example, to a dwelling that is lost in a bushfire.
Section 118-190 Use of dwelling for the purpose of producing assessable income
Confine the income producing limitation to situations where interest on a mortgage in relation to the dwelling could have been deducted.
Under the 1936 Act, the main residence exemption is reduced if the dwelling is used to produce assessable income. It is administrative practice to apply this rule only where the taxpayer would be able to deduct rates, rent or interest on a mortgage (if any), for all or such part of a dwelling as is used exclusively as a place of business. An example is when part of a dwelling is used as a doctors surgery.
Current administrative practice is to accept that the exemption is not affected where part of a dwelling is used as a home office. (Generally, rates, rent or interest are not deductible in these circumstances.) The rewritten provision adopts this administrative concession.
Replace the Commissioners discretion to reduce the exemption if a main residence is also used for the purpose of producing assessable income with a test of reasonableness.
Under the 1936 Act, the exemption may be reduced to an amount determined by the Commissioner if there is concurrent income producing use. This discretion will be replaced with an objective test more appropriate to self assessment.
Section 118-195 Dwelling acquired from a deceased estate
This section establishes when a trustee or beneficiary of a deceased estate is entitled to exemption on the disposal of a dwelling.
Provide that any occupation of the dwelling by a beneficiary, the spouse of the deceased, or an individual who had a right to occupy the dwelling under the will, during the time between death and disposal, is taken into account in determining the extent of the exemption.
Under the 1936 Act, occupation of the dwelling as a main residence by individuals within these three categories is taken into account in determining the extent of the exemption but only for specific times. For a beneficiary, this covers a time when the beneficiary owned the dwelling or had a right to occupy the dwelling under the will. For the spouse of the deceased, or an individual with a right to occupy under the will, it covers the time when the dwelling was owned by the legal personal representative of the deceased.
The rewritten section allows any occupation between the death and disposal by these three categories of persons to be taken into account.
Section 118-205 Adjustment if dwelling inherited from deceased individual
This section operates on disposal of a dwelling inherited from the estate of a deceased person who acquired the dwelling after 19 September 1985 as beneficiary or trustee of another deceased estate.
Replace with an objective test, the Commissioners discretion to increase or decrease, in certain cases, a capital gain or loss on disposal of a dwelling inherited from a deceased person.
An individual may inherit a dwelling from someone who had themselves inherited it. Under the 1936 Act, any capital gains or losses in the hands of individuals earlier in an inheritance chain are included in the capital gain or loss on the disposal of the dwelling, apart from the main residence exemption.
However, the Commissioner has a discretion to increase or decrease any capital gain or loss to take account of any time, after 19 September 1985 and before the dwelling was acquired by the deceased, that it was a main residence of:
- •
- a person who owned the dwelling at their death;
- •
- their spouse;
- •
- a person with a right to occupy under a will; or
- •
- a beneficiary.
The rewritten provision replaces this discretion with an objective formula that takes account of times when the dwelling was the main residence of any such persons.
C. Provisions of the old law not rewritten
Some provisions of the 1936 Act have not been rewritten for reasons summarised in the following table:
| Provision | Subject | Reason for omission |
|---|---|---|
| 160ZZQ(1) | Definition of dependent child | Expressly dealt with in operative rules. |
| 160ZZQ(5A), (5B) | When an election must be lodged | No formal election required under self assessment. |
| 160ZZQ(6) | Acquisition as beneficiary of a trust estate | These rules are built into the definition of passes in section 128-20. |
| 160ZZQ(6A) | Acquisition as surviving joint tenant | These rules are in section 128-50. |
| 160ZZQ(7) | Acquisition, disposal of dwelling | This provision is unnecessary. |
| 160ZZQ(11A) | Election | No formal election required under self assessment. |