Client: Shan & Zan (spouses as of January 2019)
Scenario Date: September 30, 2024
Case Summary:
Shan owned a house he purchased and used as his principal place of residence (PPR) for five years. Starting in December 2017, Shan rented out the property. Shan married Zan in January 2019 and moved in with her in her apartment, which she owns and has designated as her PPR. This case study explores how marrying affects their main residence exemption for Capital Gains Tax (CGT), including the impact of specific tax legislation.
Key Issues and Considerations
- Principal Place of Residence (PPR) Exemption Limitation Due to Marriage– Under Section 118-170 ITAA 1997, spouses generally cannot claim the full main residence exemption on more than one property at a time, unless they live permanently separately. Therefore, upon marriage, Shan and Zan must decide which property to designate as their PPR for CGT purposes. This designation affects the capital gains tax implications for both properties, especially for Shan’s house, which he has rented out since 2017.
- Absence Rule for Shan’s Property – Shan has the option to apply the 6-year absence rule for his original property, which allows him to treat it as his PPR, even while he is not living there. The rule would allow Shan to continue claiming a PPR exemption on the property until December 2023 (i.e., six years from the start of the rental period in December 2017), so long as he does not designate Zan’s apartment as their main residence during this period. This, however, would prevent Zan from applying the full main residence exemption to her apartment until Shan either sells his property or the absence period expires in December 2023.
- Option to Split the Main Residence Exemption– Alternatively, Shan and Zan may choose to split the main residence exemption across both properties. Here’s how that works:
If Shan owns more than 50% of his property, then he can treat it as his main residence (and get the capital gains tax exemption) for half of the time he’s owned it. This would mean only part of the property’s capital gain (the profit when it’s sold) would be taxed. At the same time, Zan’s apartment would also get a partial exemption for that same period, based on how long she’s owned it and lived in it.
This split setup gives Shan and Zan a partial tax break on both properties, rather than full exemption on one and none on the other. However, it requires a bit more calculation since the exemption is divided based on how much each person owns of their property and how long they’ve each lived in their homes. This option can help them reduce their capital gains tax exposure, but it’s a middle ground that means neither property is fully tax-free.
- Income-Producing Property and the “Home First Used to Produce Income” Rule
If Shan’s property does not qualify for a full exemption under the main residence rules, Section 118-192 may apply. This rule allows Shan to reset the property’s cost base to its market value as of December 2017, when it was first used to produce rental income, provided:- The property would have been fully exempt had it been sold immediately before the rental period began.
- The property was first used to generate income after August 20, 1996.
By resetting the cost base, Shan is able to limit CGT on any capital appreciation that occurred prior to December 2017. This recalculation can provide significant tax relief when determining the partial exemption for the property.
Analysis and Calculation of Exempt Portion
To calculate the CGT implications accurately, Shan’s total gain on the property disposal would be adjusted as follows:
- Determine Gross Capital Gain: Calculate the gain based on the deemed acquisition date from December 2017 not the actual purchase date.
- Apply the Absence Rule:
- If Shan applies the absence rule for the initial 14 months of the rental period (up to January 2019), the exempt portion would be calculated as:
- If Shan applies the absence rule for the initial 14 months of the rental period (up to January 2019), the exempt portion would be calculated as:
- Partial Main Residence Exemption: Apply this partial exemption calculation to determine the non-exempt portion of the property’s gain that will be subject to CGT. This approach ensures that only the relevant period outside the absence rule is taxable.
Conclusion
For Shan and Zan, careful tax planning around their principal place of residence (PPR) designation is essential to minimize capital gains tax (CGT) when selling Shan’s property. They have several options: they could apply the 6-year absence rule to Shan’s property, allowing him to maintain his CGT exemption until December 2023, though this would limit Zan’s ability to claim a full exemption on her apartment. Alternatively, they could choose to split the main residence exemption, which provides partial relief for both properties, calculated based on their respective ownership shares and periods of occupancy. Additionally, since Shan’s property was rented out for more than six years, the cost base must be reset to its market value at the time he first rented it out, automatically reducing CGT on any appreciation before the rental period began. Each option has distinct tax impacts and timing considerations. If you’re facing a similar situation and aren’t sure how to navigate these choices, contact an Investax Property Tax Specialist for expert guidance.