Q: I own two properties, the second of which I have owned for around seven years. During this period it has never been rented, therefore it’s never earned an income. My immediate family have lived in it rent-free.
I assume that when it is sold I will have to pay capital gains tax. Am I correct in this assumption? Also, will any monies spent on it during this period be allowed as a tax deduction to reduce the capital gains tax payable?
A: As per the Australian Taxation Office, you are typically exempted from paying capital gains tax for a main residence. Specifically, the property must contain a dwelling, and you must have resided in that dwelling. The ATO lists the characteristics of a main residence as follows:
- You and your family live in it.
- Your personal belongings are in it.
- It’s the address your mail is delivered to.
- It’s your address on the electoral roll.
- Services such as gas and power are connected.
Thus, to sell a home tax-free under the main residence exemption (even for a partial exemption) the home must have been your main residence at some time. The ATO’s conditions for earning a full main residence exemption are:
- The property has been the home of you, your partner and other dependants for the whole period you’ve owned it;
- The property has not been used to produce assessable income – that is, you’ve not run a business from it, rented it out or flipped it; and
- The property is on a land area of two hectares or less
You mentioned that your immediate family has lived in this second home rent-free; however, if it has never been your main residence, you will not enjoy the main residence exemption under the Tax Act.
However, just because you cannot use the main residence exemption does not automatically mean you will pay capital gains tax (CGT). You only pay CGT based on the net profit between the sales price of the home and the net purchase price of the home, called the ‘cost base’. The cost base of your home includes the following:
- The money paid to acquire the asset
- The incidental costs of acquiring the asset (such as stamp duty)
- The costs of owning the asset
- The costs of improving or preserving the asset
- The costs of defending your rights to own the asset
The money spent on holding the home – like council rates, mortgage interest or land tax – will form part of the third category. Likewise, the cost of any home extension, renovation or improvement to the house will form part of the fourth category.
These costs of holding and improving a home can add up, especially over time. So reconstructing your tax history can reduce the CGT payable. A talk with your bank and local government council can help reconstruct your tax history.
Including these additional amounts when determining your cost base can eliminate the tax payable on the sale of an asset. And if you are still generating a taxable profit, you could then look at the 50% CGT discount.
Your estate plan should also include tax advice profiling the tax outcomes of your investment portfolio, including a cost base history. This will allow your executor to easily identify these issues if you are not around.
Need to know
- You must have lived in a property for it to be considered your main residence.
- The property’s cost base is used in the calculation of CGT.
- Reviewing your tax history can confirm if you need to pay full CGT.
is director of Westcourt
Family Business Accountants
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