Tax Q&A: Exposure to Capital Gains Tax

A: We bought an investment property in 1999 for $184,000 and the purchase was in the income earner’s name for tax (negative gearing) purposes. Over the period 1999–2017, the capital value has increased considerably, based primarily on appreciating land value. The house is simple, basic and dated but tidy, and it is now worth around $1.1m. The capital gain to date is around $916,000.

We are now retired and contemplating downsizing by selling our current permanent residence in the city and investing around $550,000 of the sale funds into developing the investment property as our new residence outside the city. This will involve paying out the remaining mortgage on the investment property, demolishing the existing building and building a new one, which will be our new and only place of residence.

My understanding is that CGT events are only triggered by the sale of the property asset; however, given that we will not be selling the investment property and will be residing permanently in the new building from around May 2020, does the capital gain exposure continue? Is there any mechanism to ‘rule off ’ the ongoing capital gains tax exposure from the point of occupancy of the new building?

We are not comfortable with the thought of investing in a major development of the property and having it be subject to a further increase in CGT liability – we are interested in what options are available to prevent this.

- Thanks, John 

A: As soon as you move into your investment property the exposure to capital gains tax (CGT) is frozen. And yes, your exposure to CGT is only payable when the property is sold. When you eventually sell the property, a component of the sale proceeds will be subject to CGT, but the other component will be tax-free under the principal place of residence exemption rules.

To calculate the component that is subject to CGT, you simply take the period of time when you rented the property out, ie from 1999 until May 2020, as a percentage of your total period of ownership of the property. There is a great little online tool on the ATO website to work out this time calculation – just search on the website for ‘CGT property exemption tool’.

This percentage will be applied to the capital gain when you sell the property. Bear in mind that you can also deduct any costs that you incurred in improving or renovating the property. And don’t forget that at the time of writing and under the current rules, ie of the Scott Morrison government, only 50% of the capital gain on the sale will be taxable.

Remember to keep really good records of all the costs you incur in demolishing the old house and building the new one. Often people discard these records as they are not immediately tax deductible. If the property is left to your children in your will, for example, then it would be really useful to give them a folder (or nowadays a USB stick) with a copy of your purchase contract, receipts for the demolition, and also all the receipts for the construction of the new house. This will be extremely valuable to them when they sell the property in the future.

There isn’t any form that you need to complete to advise the Tax Office that you have moved into the property. However, make sure you are diligent about transferring over your residential address on all of your ‘Proof of Identity’ documents as soon as you move into the property, for example on your driver’s licence and bank statements and on the electoral roll. That way, if you are ever asked by the Tax Office in the future to provide proof of the date of moving into the property, you will be able to provide a paper trail quite easily.

Need to know

• CGT exposure is frozen when you move into an investment property.
• It’s important to keep good records of expenses related to your property.
• Online tools on the ATO website can help you calculate the CGT-taxable period.

Kym Nitschke

is managing partner at

Nitschke Nancarrow Chartered Accountants