In the 2017 Federal Budget, the Government announced a number of measures relating to housing affordability, including around capital gains tax (CGT). One measure which is now law1 is the removal of the main residence CGT exemption for non-residents of Australia for tax purposes (henceforth referred to as ‘foreign residents’).
Whilst few are impacted by this change, for those who are, the impact may be significant and requires immediate consideration.
What is the main residence CGT exemption?
The main residence CGT exemption generally allows a taxpayer to receive a full CGT exemption upon selling a property in which they have resided for their full ownership period.
Usually a partial CGT exemption applies where a taxpayer has resided in the property for part of the ownership period, however the full CGT exemption extends to situations where the taxpayer is/has been ‘absent’ from their main residence subject to the following criteria:
- The owner of the property established the property as their main residence as soon as practical after purchasing, and
- The owner does not treat any other property as their main residence during the relevant period, and
- The period of absence is less than 6 years if the property is used to produce income during their absence, or if the property is not used to produce income during their absence the exemption can continue indefinitely.
Adviser tip: Even the ‘standard’ rules relating to the main residence CGT exemption, particularly the application of the absence provision are quite complex. If you are unfamiliar with the area of the tax system or would like a refresher, this link to the ATO explains in more detail.
What is the change?
Under the new rules, even if the requirements relating to the 6 year/indefinite absence provision outlined above are satisfied, those who sell their main residence whilst a foreign resident will not be eligible to claim the main residence CGT exemption.
In such situations, the individual will not even be eligible for a partial exemption for the period they resided in the residence.
As is the case for investment properties, upon the foreign resident selling their former main residence, the ordinary 50% CGT discount is not available for the period of foreign residency after 8 May 2012. Also, the resulting capital gain will be taxed at non-resident rates.
The new law contains transitional relief. A taxpayer is not subject to the new rules if they owned the property before 7:30pm (Australian Capital Territory time) on 9 May 2017 and dispose of the property on or before 30 June 2020.
There are also exemptions if the property owner experiences ‘certain life events’ during their period of foreign residency and has been a foreign resident for a continuous period of six years or less at the time of the CGT event.
Certain life events during the period of foreign residency are:-
- The property owner, or their spouse, or their child under age 18 has had a ‘terminal medical condition’ that existed at any time during that period of foreign residency.2
- The property owner, their spouse or their child under age 18 passes away during the period of foreign residency.
- The CGT event occurs because of one of the matters in Income Tax Assessment Act 1997 section 126-5(1). Broadly these relate to relationship breakdowns where there is either a court order under the Family Law Act 1975, or one of various agreements between the parties where a specific legal process is followed.
It should be noted that upon ceasing to be an Australian resident for tax purposes, a taxpayer may make an election for certain assets they own to be treated as a deemed disposal for CGT purposes. This is known as an I1 election (named after the applicable CGT event) and may be made for assets which are not considered ‘taxable Australian property’ such as listed shares and managed funds.
This I1 election cannot apply to taxable Australian property such as residential property located in Australia.
Who is impacted and strategy considerations
Anyone who is currently, or is considering becoming a foreign resident may be impacted if they own property which (upon sale) would otherwise satisfy the criteria to benefit from the main residence CGT exemption.
As the new law targets those selling such properties whilst a foreign resident, clearly doing so is likely to result in an adverse CGT outcome. Depending on the specific scenario, alternatives to consider include:
1. For taxpayers who are currently foreign residents, sell the property before 30 June 2020 in order to benefit from the transitional rules (so long as they owned the property before 7:30pm (AEST) on 9 May 2017). This option could be the most attractive for those who are never likely to regain Australian residency for tax purposes.
2. For taxpayers who are currently foreign residents, delay any intended sale until they have regained Australian residency for tax purposes. This option could be the most attractive for those who are confident that they will permanently move back to Australia in the future.
3. For taxpayers who are currently Australian residents for tax purposes, but will likely become a foreign resident in the near future, consider selling the property prior to the later of their departure overseas or 30 June 2020 (so long as they owned the property before 7:30pm (AEST) on 9 May 2017). This option could be the most attractive to those who upon departure will never likely permanently return to Australia, or those who do intend to permanently return to Australia in the future but would otherwise likely sell the property whilst a foreign resident.
Adviser tip: Australian residency for tax purposes is a completely different concept to citizenship/residency status for immigration purposes. This link to the ATO outlines the factors which are used to determine a person’s tax residency status.
Dale (single - age 45) purchased a residential property in Sydney for $1,000,000 on 05/06/2012, moves into this property as soon as practical, and will not claim the main residence CGT exemption for any other property.
He continues to reside in his Sydney property until leaving Australia on 30/01/2018 to take up a 4 year work contract in the UK where his employer will provide him with accommodation as part of his remuneration package.
During his 4 year stint in the UK, Dale will become a foreign resident and will rent his Sydney property to a 3rd party. Dale is confident that at the expiry of this contact he will permanently return to Australia.
Let’s look at 4 potential scenarios for Dale:
Scenario 1: Dale sells his Sydney property on 26/06/2020 for $1,600,000.
Dale is not impacted by the change as he is eligible to claim the full main residence CGT exemption.
This is because he owned the property before 9 May 2017 and the sale has occurred on or before the expiry of the transitional relief period (30 June 2020).
Scenario 2: Dale sells his Sydney property on 03/07/2020 for $1,600,000 and none of the ‘certain life events’ exemptions apply.
Dale is impacted by the change. Unlike scenario 1, as the sale (based on date of contract) occurs after 30 June 2020 whilst Dale is a foreign resident, he is not eligible for the main residence CGT exemption, even for the period he resided in the property.
As a result $600,000 ($1,600,000 - $1,000,000) is Dale’s total capital gain for 2020/21. He is eligible for the ordinary 50% CGT discount for his period of Australian tax residency, however he is not eligible for the ordinary 50% CGT discount for the period of foreign residency. This results in $390,0003 being included in his assessable income for 2020/21 which will be taxed at non-resident rates. Depending on Dale’s level of income (such as rent) which is taxable in Australia, the sale would result in a tax liability of between $157,050 and $175,550.
Scenario 3: Upon his return to Australia, Dale reattains his Australian tax residency on 30/01/2022, and moves back into his Sydney property. He subsequently sells the Sydney property on 04/10/2022 for $1,700,000.
Dale is not impacted by the change as he is eligible to claim the full main residence CGT exemption.
This is because Dale has sold the property whilst an Australian resident, is eligible to claim the CGT main residence exemption during the period in which he resided in his Sydney property (05/06/2012 – 29/01/2018 and 30/01/2022 – 04/10/2022) and may apply the 6 year absence provision for the period he was working in the UK (30/01/2018 – 29/01/2022).
Scenario 4: Upon his return to Australia, Dale reattains his Australian tax residency on 30/01/2022, decides to live and rent in Melbourne and continues renting his Sydney property to a 3rd party. He subsequently sells the Sydney property on 04/10/2022 for $1,700,000.
Dale is not impacted by the change as he is eligible to claim the full main residence CGT exemption. This is despite not re-establishing his Sydney property as his main residence upon his return to Australia.
This is because Dale has sold the property whilst an Australian resident, is eligible to claim the main residence CGT exemption during the period in which he resided in his Sydney property (05/06/2012 – 29/01/2018) and may apply the 6 year absence provision as his total period of absence from the Sydney property (30/01/2018 – 04/10/2022) is less than 6 years.
Adviser tip: As Dale’s situation above illustrates:
- If in the short to medium term a foreign resident wishes to sell a former main residence (which they purchased before 9 May 2017), it may be beneficial to do so prior to 30 June 2020.
- Otherwise (i.e. if this transitional exemption does not apply), selling the property whilst a foreign resident is likely to result in the worst possible CGT outcome.
If you would like further information, please contact the Technical Services team on 1800 655 901 or firstname.lastname@example.org
1- The ‘Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures) Bill 2019’ which has passed both houses of Parliament and received Royal Assent on 12/12/2019
2- For a child of the foreign resident, it is necessary that during at least part of the period of foreign residency the child was suffering from a terminal medical condition.
3- Total ownership period = 2,951 days (05/06/2012 – 03/07/2020)
Total period of Australian tax residency = 2,065 days (05/06/2012 – 29/01/2018)
Proportional discount = 35% [2,065 / (2,951 x 2)]
Assessable income = $390,000 [$600,000 - ($600,000 x 35%)]
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