MAIN RESIDENCE TAX EXEMPTION: A Gotsis Accounting Case Study

November 24, 2012

How do you apply the main residence exemption if you own more than 1 property which has been used as your main residence? In this case study, we examine how to apply the main residence exemption rules.

Take these facts for example:

Sam purchases a property in Melbourne on 1 July 2004 for $200,000 and moves into it straight after settlement takes place.

On 31 August 2007, Sam’s employer relocates Sam to Sydney for a long term project.

As a result, Sam rents out his Melbourne property on 1 September 2007 and lives in rented accommodation in Sydney.

Sam meets his wife in Sydney. They decide to stay in Sydney and buy a property in Five Dock under joint names on 1 August 2009. They move into their Five Dock property straight after settlement.

On 1 August 2012, Sam sells his Melbourne property.

Assuming Sam’s wife does not own any other dwelling, here’s how the law works:

Sam can claim an exemption from capital gains tax (“CGT”) for a dwelling which has been used as his main residence. However, as he had rented out his Melbourne property for a part of the time he owned it, he will only be able to obtain a partial exemption.

There is a special rule which would allow Sam to rent out his Melbourne property and still elect to treat it as his main residence for CGT purposes for up to 6 years. However, to utilise this special rule, Sam cannot treat any other dwelling during this period as his main residence.

Let’s say the Five Dock property has increased in value more than his Melbourne property. As Sam can only treat 1 property as his main residence at a given time, it would be make more sense for Sam to treat his Five Dock property as his main residence during the period when he owned both properties. Therefore, his Melbourne property can only be treated as his main residence up to the time he purchases his Five Dock property, even though that was less than six years after he has vacated and rented out his Melbourne property.

As a result, Sam can obtain a partial capital gain exemption on the disposal of his Melbourne property, with the full exemption being proportionately reduced by reference to the number of days it is not treated as his main residence.

In addition, because Sam first started renting out his Melbourne property after 20 August 1996, there is a special revaluation rule that would apply. Under this rule, Sam is deemed to have purchased his Melbourne property on 1 September 2007 for its market value at that time, being the date he first started earning income from it. This effectively means is that any capital gain he made during the period he lived in it is ignored.

Let’s say Sam sold his Melbourne property for $450,000 and its market value was $300,000 on 1 September 2007. Putting everything together, this means that Sam’s capital gain is $150,000 (being $450,000 less $300,000), even though Sam only paid $200,000 for the property. The taxable capital gain would then be calculated as follows:

$150,000 x 1096 (non main residence days)

1796 (days in deemed ownership period)

= $91,537

The gain could be reduced further once Sam factors in other costs he incurred with respect to the property such as selling agent fees and legal fees.

In addition, as Sam owned his Melbourne property for more than 1 year from the time he started renting it out, he can apply a 50% CGT discount. Hence the net gain to be included into his tax return with respect to the sale of his Melbourne property (excluding selling agent fees etc) is $45,768, which would be taxed at his marginal tax rates. Not bad for a ‘real gain’ of $250,000 (being $450,000 less $200,000)!

Assuming Sam does not use his Five Dock property for any income earning purposes, he will be able to obtain a full CGT main residence exemption when he eventually sells his Five Dock property.

Please do not hesitate to contact us on 1300 757 118 if you would like to know how we can help you with calculating the main residence exemption in your situation.