Beware the Pitfalls of the Principle Place of Residence Exemption and the 6-Year Absence Rule

By David Shaw. 31/08/2016
Recently we had a situation where a taxpayer who had a principle place of residence, and had actually lived in the property for a number of years, subsequently sold that property. 
The facts during the ownership of the property were as follows:
  Purchase details Sale details
Price $122,500 $280,000
Date 16 September 2001 6 June 2014
 
As some of the readers may be aware, the Tax Office allows taxpayers who have lived in a property as the principle place of residence to subsequently rent that property out for a period of 6-years and as long as they move back into that property and subsequently sell that property, no capital gains tax will apply as long as that property continues to be their only principle place of residence.
 
Unfortunately, in the case of this taxpayer, they were unable to move back into the premises after the 6-years.  This resulted in the following occurring:
 
  1. A valuation of the property is backdated to 1 May 2002 to when the taxpayer moved out of the property.
  2. A valuation then has to be provided for the property based on the beginning of the 6-year period (1 May 2002) and the property is classed as a principle place of residence for the 6-years.
  3. The total number of days the property is owned is then calculated and the difference between the net sale price and the valuation as at May 2002 is calculated and apportioned between the number of days the property was the principle place of residence and the number of days the property was not the principle place of residence.
 
In the example below, we have provided detailed calculations of how a final assessment was made on the capital gain.
 
Market value at income time $130,000  
Estimated purchase, sale and other costs* $28,000  
Total cost base   $158,000
     
Capital proceeds from disposal of the property   $280,000
     
Gross capital gain   $122,000
(Capital proceeds reduced by cost base)    
Taxpayer’s share of capital gain   $122,000
Non- main residence days 1/5/08 to 29/7/14 2,281 days  
Ownership period 1/5/02 to 29/7/14 4,473 days  
Capital gain per subsection 118-185(2)   $62,213
Less any applicable capital losses   $0
Capital gain prior to discount   $62,213
Applicable discount for eligible transactions   50%
     
NET CAPITAL GAIN   $31,106
 
In this case, the taxpayer already had net taxable income of $61,091 and with the additional capital gain of $31,106, the taxpayer’s taxable income became $92,197.  This resulted in an extra $11,209 worth of tax which needed to be paid.
The taxpayer previously argued that the capital gain should be calculated on the difference between the market value of the property at the end of 2008 and the final sale price.  This would have been a net capital gain of only $12,505, of which the taxpayer had already paid $4,768 of additional tax. 
The additional $6,441 capital gains tax due to the adjustment to correctly reflect the additional amount which the taxpayer had to pay could have been avoided, at least in part, by the following:
  1. The taxpayer getting a valuation on the property as soon as they moved out of the property in May 2002 – because the taxpayer did not have a valuation on hand, the Tax Office used its own valuation.This meant that the taxpayer had to go and get their own valuation to dispute this.
  2. The taxpayer should have considered moving back into the property within the 6-years which would have “refreshed” the principle place of residence exemption.
  3. The taxpayer also made the mistake of assuming the capital gain is calculated on settlement date as opposed to the contract date.Taxpayers must be aware that the contract date is the date which the gain will be assessed.
..................................................................................................................
 


David Shaw is the CEO of WSC Group: Certified Practising Accountants and Business Advisors, and
was voted Property Tax Specialist of the Year in the Your Investment Property 2013 Readers Choice Awards (as well as runner up in 2012, 2014 & 2015).

 


*The advice published on social media mediums by WSC Group is of a general nature and does not constitute specific financial advice.  For a detailed financial strategy you should consult with a qualified financial advisor before making any investment decision.
Disclaimer: while due care is taken, the viewpoints expressed by contributors/sponsors do not necessarily reflect the opinions of Your Investment Property.


 

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