On 12 December 2019, the law has changed to deny CGT Main Residence Exemption to foreign residents. Taxpayers who are foreign residents at the time of CGT Event happening to their main residence can no longer disregard capital gain (in full or in part), unless certain exceptions apply.
The new law applies retrospectively from 7.30 pm (AEST) 9 May 2017.
Exceptions: Life Events Test
There new law will not prevent you from disregarding Capital Gain if CGT Event happens to your residence less than 6 years after you cease to be a resident and one of the following life events occur:
– you or your spouse has had a terminal medical condition that existed at any time during that period of foreign residency;
– your child has had a terminal medical condition that existed at any time during that period of foreign residency, and that child was under 18 years of age at at least one such time;
– your spouse, or your child who was under 18 years of age at death, has died during that period of foreign residency;
– the CGT asset is transferred as a result of divorce or separation under a court order, maintenance agreement or similar arrangements between you and your spouse.
Under Transitional Provisions, the new law will not apply to you if you are a foreign resident at the time of disposal, and:
- you continuously held the property from immediately prior to 7:30 pm (AEST) on 9 May 2017 until the CGT Event happens; and
- disposal happens on or before 30 June 2020
Originally, Transitional Provisions were intended to end on 30 June 2019, but the original Bill proposing law changes lapsed on 1 July 2019, and the measures were reintroduced to Parliament in October 2019. As a result, Transitional Provisions were extended till 30 June 2020 providing a window of opportunity to foreign residents to sell their main residence.
How the new CGT Main Residence Exemption law applies?
Residency status at the time of disposal
The most significant feature of the new law is that eligibility for CGT Main Residence Exemption is determined by your residency status at the time of CGT Event. That is the time when the contract for sale is entered into.
If you are a foreign resident at the time of disposal, you will not be entitled to Main Residence Exemption.
No apportionment of Main Residence Exemption
It is important to note that the new law does not take into account how long you had been a resident during property ownership period prior to disposal. There is no ability to apportion the exemption.
Interaction with Absence Rule
No changes were made to the Absence Rule (also known as “6 Year Rule”), so the rule continues to apply. However, applying the rule will have no practical effect under the new law if you cease to be a resident before the CGT event, unless certain life events occur, or you re-establish your residency upon your return before disposing of the property.
No Cost Base reset to Market Value when property first used for income producing purposes
There is a special rule that applies when main residence property is first used to produce assessable income. You are deemed to have acquired the dwelling at Market Value at that time if the first use occurred after 20 August 1996 and you would be eligible for a full Main residence exemption if the CGT event happened just before that time.
However, application of this rule is hinged upon eligibility for main residence exemption. To trigger this special rule, you must be eligible for partial exemption when the CGT Event happens. As was previously mentioned, taxpayers who are foreign residents at the time of the event are not eligible even for partial exemption. Therefore, the special rule does not apply to them.
Joe had been an Australian resident since birth. He purchased his home on 1 July 2000 for $250,000 and used it as his main residence.
During the time he resided in the property, he incurred additional costs of $80,000 to make substantial renovations to the property. He also incurred $150,000 of interest on the loan used to purchase the property. The loan was fully repaid in 2015.
In early 2016, Joe met his partner on online dating website and decided to permanently move overseas to get married and establish his new home. He ceased his Australian tax residence on 1 July 2016 leaving Australia with no intention to return.
His former main residence property was rented out for the first time on the same day, on 1 July 2016.
Joe’s Accountant advised him to obtain market valuation for the property as at 1 July 2016 as it would become the new cost base in the event the property is sold (the advice was given before the changes to law were announced). The property was valued by certified valuer to be worth $900,000.
Joe then decided to sell the property but had difficulties negotiating sale price with prospective buyers. He finally signs a contract to sell his property for $1,000,000 on 1 July 2020.
CGT Consequences for Joe:
- Joe signed a contract to sell the property after 30 June 2020. Transitional provisions no longer apply.
- As Joe is a foreign resident as at 1 July 2020 (time of CGT event), he is not eligible for Main Residence Exemption and his Capital Gain will have to be recognised in full. This is irrespective of how long he had been a resident during ownership period. In other words, he will not be able to claim partial exemption based on his residency period of 16 years out of 20 years of property ownership.
- If Joe elects to continue treating this property as his main residence up until the date of disposal under 6 Year Rule (Absences Rule), it will have no effect on application of the new law denying main residence exemption as eligibility depends on his residence status at 1 July 2020. He is unable to postpone change of his residence status by applying the 6 Year Rule to qualify for 100% exemption.
- Joe will not be able to reset cost base to Market Value on 1 July 2016 when he starts using his property to produce rental income for the first time. The cost base would be the acquisition and other costs incurred on the property.
- Note that Joe is still eligible for partial General GCT Discount as he owned the property for longer than 12 months. As he was an Australian resident at 8 May 2012, the 50% discount will be reduced on pro-rata basis based on number of days he was a resident during ownership period.
Joe’s CGT Capital Gains would be:
Proceeds on Sale: $ 1,000,000
Acquisition $ 250,000
Renovations $ 80,000
Interest (ineligible for deduction) $ 150,000
Total Costs $ 480,000
Capital Gain (Gross) $ 520,000
Less General Discount 40.00% $ 208,000
Net Capital Gain $ 312,000
If sale of property occurs on 30 June 2020, while the Transitional Provisions are still in place, Joe would recognise Market Value of the property at 1 July 2016 being $900,000 as its cost base.
His Capital Gain would be:
Proceeds on Sale: $ 1,000,000
Market Value at 1 July 2016 $ 900,000
Capital Gain (Gross) $ 100,000
Less General Discount 40.00% $ 40,000
Net Capital Gain $ 60,000
Alternatively, he may elect to treat the property as his main residence up until the date of disposal under the Absences Rule, provided he doesn’t treat any other property as his main residence during that time. In this case, Market Valuation rule will not apply but the Capital Gain would be fully exempt.
Cost Base Substantiation issue
The new law creates practical difficulties for ascertaining cost base. It applies to deny Main Residence Exemption retrospectively. Home owners would not have foreseen these changes when they incurred capital costs and would not have kept the receipts. They would not be able to rely on estimates when calculating CGT Cost base as full substantiation is required. In the example above, if Joe has not kept receipts for renovation works, he would not be able to include $80,000 in his cost base.
The changes will not affect Temporary residents who are Australian Residents for tax purposes. Temporary residents include holders of special category visas living in Australia.
The new law does not apply if you re-establish your residency before selling your property as you would not be a foreign resident at the time of CGT event. You can continue to treat your property as your main residence for up to 6 years during period of your absence if you use it to produce assessable income. If you do not use it for that purpose, you can treat it as your main residence indefinitely.
Interaction with Main Residence exclusion for the purpose of $6 million Maximum Net Asset Value (MNAV) test for Small Business CGT Concessions
The new law applies to deny foreign residents the ability to disregard Capital Gain from main residence but it does not imply the dwelling cannot be treated as a main residence.
Main residence of an individual, including adjacent land, is excluded from MNAV calculation to the extent it has not been used to produce assessable income where interest incurred on acquisition of the property would be deductible. The new law does not affect this calculation as the exclusion of Main Residence from MNAV Test does not depend upon application of s 118-110.
Do you need assistance with determining eligibility for Main Residence Exemption or any other CGT Issue? As a Capital Gains Tax Specialists, we are able to help!
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