Capital gains tax on selling an aged care resident’s former home
When an elderly resident enters an aged care home it is common practice to keep the family home because:
- retaining the former home usually results in a higher Centrelink payment and lower aged care fees. This is due to the concessional treatment of the resident’s former home for social security and aged care purposes, and/or
- the spouse, a relative or a carer is living in the home and has an ongoing need to use it as their place of residence.
The benefits of retaining the resident’s former home are often discussed and are reasonably well-known to many people. However, the capital gains tax (CGT) consequences that stem from selling the former home are often not understood.
While the application of the CGT rules are complicated, it is very important to understand how CGT can affect an individual’s wealth management and estate planning strategies. It should be part of the discussion to determine whether the family home should be retained or sold when an individual moves to an aged care home.
This article outlines the rules surrounding the capital gains tax (CGT) main residence exemption and how the rules are applied in different scenarios, in particular when a beneficiary disposes of the inherited property owned by a deceased aged care resident.
All legislative references in this article are references to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.
While the Government is removing the entitlement to the CGT main residence exemption for a foreign resident, this article only explains the rules in relation to properties owned and sold by Australian tax residents.
The basic rules of the main residence CGT exemption:
Assets acquired since CGT started, on 20 September, 1985, are subject to CGT unless specifically excluded, such as, an individual’s main residence. A main residence is loosely defined as someone’s home.
A capital gain or capital loss arising from selling a home can be exempt from CGT. The main residence CGT exemption extends to up to two hectares of land adjacent to the dwelling. The land and the dwelling do not need to be on the same title, however, the land needs to be sold together with the dwelling to get the CGT exemption.
Full exemption
The full main residence CGT exemption is available if the dwelling:
- has been the home of the individual, their partner and other dependent children for the whole ownership period, and
- has not been used to produce assessable income, for example running a business from it or renting it out.
If the full exemption applies, the capital gain or loss from selling the dwelling is disregarded.
It is important to note that in order to use the full main residence CGT exemption, the individual must move into the property as soon as practicable after it was acquired.
If the property is rented out, left vacant or the individual chooses to treat another property as their home under the absences rule (see below) before the property is established to be the main residence, the full main residence exemption is not available.
Absences rule – an individual continues to treat a dwelling as the main residence after moving out
Generally, a dwelling is no longer an individual’s main residence once they stop living in it. However, the tax law provides some flexibility and allows the individual to choose to continue treating a dwelling as their main residence for CGT purposes, although the individual no longer lives in it. This is called the absences rule (sections 118-145).
Under this rule, the individual:
- can continue to treat the dwelling as their home for:
- up to six years if the property is rented out to produce income, or
- indefinitely if it is not used to produce income.
- cannot treat any other property as their main residence for that period even if they are living in it.
If the property is re-established as the individual’s home, another choice can be made to continue to treat the property as their home even after they move out again. Another six years limit applies during the new absence period that the property is rented out.
Partial exemption
If a property is not the individual’s main residence or their deemed main residence under the absences rule for the entire ownership period, the home can only be partially exempt for CGT purposes.
The full CGT main residence exemption is proportionately reduced by reference to the period for which the dwelling was not the individual’s home. The formula below is used to calculate the proportioned gain or loss before applying any CGT discount:
Total capital gain/loss from selling the property
x
(Non-main residence days / Days in the ownership period)
Please note that the days the individual chooses to continue treating the property as their main residence after moving out under the absences rule are counted as part of the main residence days.
Special rules apply when the property is sold by the executor of the deceased estate or a beneficiary. This type of situation is discussed later in this article.
Special rule for where the home first becomes income-producing after 20 August, 1996
Under this special rule (sections 118-192), an individual is considered to have acquired the property at the time it is first used to produce income. Effectively, this allows the capital gain accrued during the main residence period to be fully exempt and the cost base of the property for CGT purposes is reset to the market value from when it is first rented out.
This special rule does not apply to a property that is eligible for the full exemption. The capital gain or loss is disregarded under the full exemption.
Under the partial exemption, this special rule to reset the cost base and acquisition date applies if the below conditions can be met:
- The property was first used to produce income after 20 August, 1996, and
- The full main residence exemption would have been available if the property was sold just before the property was first used to produce income.
This special rule does not apply (ie the original cost base applies) if:
- the property was first used to produce income before 20 August, 1996, or
- the property was not established as the main residence as soon as practicable after it was acquired. This includes the situation where the individual chooses to treat their former home as their main residence under the absences rule, even though they are living in the newly acquired property.
Properties inherited from a deceased estate
If a beneficiary inherits a dwelling and later disposes of it, they may be fully or partially exempt from CGT. The previously mentioned absences rule and the special rule for when the home first becomes income producing also interact with the main residence CGT exemption rules for inherited properties.
Full exemption
The full exemption generally applies if:
- the deceased acquired the property before 20 September, 1985, or
- the deceased acquired the property on or after September, 1985 and the property was the deceased’s main residence and was then not being used to produce income just before the death.
- for this purpose, the use of the property to produce income can be disregarded if the deceased chose to treat this property as the main residence under the six-year absences rule. This is particularly important for an aged care resident who retains their former home and uses it to produce rental income to subsidise their aged care home costs.
And one of the following applies:
- The beneficiary disposes of the property within two years of the date of death. This is the case even if the property is used to produce income during that period, or
- The surviving spouse or someone who had a right to occupy the property under the deceased’s will lives there until the disposal, or
- The beneficiary uses it as their main residence during their ownership period.
Partial exemption
If the full exemption is not available for an inherited dwelling, the beneficiary may be entitled to a partial exemption. The proportioned capital gain is calculated as per the sections 118-200 formula:
Total capital gain from selling the property
x
(Non-main residence days / Total days)
The application of this formula can be very complicated so we will look at it at a high-level.
1. Total capital gains and total days
It’s important to determine the cost base of the property in order to calculate the total capital gain. Section 128.15 details the modified cost base of an inherited property in the hands of the beneficiary due to different circumstances.
The cost base to the beneficiary and total days are shown in the below table.
|
Situation |
Cost base to the beneficiary
|
Total days |
Unfortunately, any use of the property by the deceased to produce income under the six-year absences rule cannot be ignored for the purpose of establishing a beneficiary’s cost base.
|
Market value of the property on the day of death. |
From the day of death to the disposal date. |
|
The cost base of the deceased. |
From the deceased’s acquisition date to the disposal date. The special rule where the home first becomes income-producing can modify the deceased’s acquisition date. |
|
Market value of the property on the day of death. |
From the day of death to the disposal date. |
2. Non-main residence days
This is the sum of the non-residence days of the deceased and the beneficiary in the relevant period, however, the below specified non-residence days are ignored:
The non-main residence days of the deceased if the property was purchased before 20 September, 1985 (ie pre-CGT property),
The non-main residence days of the deceased if the property was the deceased home and was not used to produce income just before the day of death, and
The non-main residence days of the beneficiary when the property was occupied by the surviving spouse of the deceased or a person who had a right to occupy the property under the deceased’s will.
For this purpose, the days where the former home is treated as the main residence under the absences rule, even after the deceased had moved out, are also not counted.
3. 50 per cent CGT discount
The 50 per cent CGT discount is available if the ‘total days’ are 12 months or more.
Examples – bringing it all together
These main residence CGT exemption rules can be difficult to comprehend in isolation. How to apply the rules is more easily understood by using some real-life examples.
Example 1: Single aged care resident
Sam entered an aged care home in 2011 and he died in 2016. His former home, a post-CGT asset, was rented out during the five-year period he was at the aged care home. Sam continued treating his former home as his main residence for CGT purposes during his stay in the age care facility.
His daughter Anna inherited Sam’s former home nearly two years ago. She has been renting this property out ever since she inherited it.
The property was valued at $300,000 in 2011 when it was rented out for the first time.
Situation 1: Anna sells this inherited property within two years of Sam’s death
The full exemption applies to this inherited property if Anna sells it within two years of Sam’s death and any capital gain is disregarded. This is because:
the post-CGT property was Sam’s main residence under the six-year absences rule and any use of this property to produce income during this period is disregarded for this purpose, and
the property is sold within two years from the date of death.
Situation 2: Anna sells this inherited property in 2018, more than two years after Sam’s death
The full CGT main residence exemption is not available to Anna if this property is sold after the two-year period.
To apply for the partial CGT main residence exemption, the first step is to establish the cost base of this property for Anna.
Anna’s situation falls under situation 2 in the above cost base table. This is because Sam’s property was used to produce income just before his death. Although this property was still deemed to be Sam’s home under the absences rules and the rental period is under six years, the fact it was used to produce income cannot be ignored for establishing the cost base purposes. As a result, Sam’s cost base would pass to Anna.
Due to the application of the special rule where the home first becomes income-producing after 20 August, 1996, the cost base of this property is reset to the market value when it was first rented out in 2011.
Assuming Anna sold the property for $600,000, she would make a gross capital gain (sale proceeds of $600,000 – market value when property was first rented out $300,000 – other incidental costs) of approximately $300,000, the proportioned gain is:
Total capital gain from selling the property
x
(Non-main residence days*/Total days)
= $300 000
x
(From year 2016 to year 2018 (non-main residence days*) / From year 2011, when the property was first rented out, to year 2018 (total days^))
* The non-main residence days do not include the days where Sam chose to continue treating the former home as his residence under the absences rule after he moved to the age care home.
^ Technically speaking, the days need to be used to do the calculation. The years are used for illustration purposes.
= $300,000 x 29 per cent
= $87,000
After applying the 50 per cent CGT discount, the $43,500 assessable gain will form part of Anna’s assessable income in the year the property is sold.
Comparatively, if Anna sells the property within two years of Sam’s death (situation 1), any capital gain from the sale will be disregarded.
Situation 3: Property was rented out for more than six years before Sam’s death
Assuming Sam stayed in the aged care home for seven years instead of five years before he died and his former home was rented out during that period.
In this situation, because the property was rented out for more than six years, it can no longer be Sam’s main residence at the time of his death.
Accordingly, even if Anna sells this property within two years of Sam’s death, the full main residence CGT exemption does not apply. The cost base of this property for Anna is the market value when it was first rented out in 2011 and the calculation of the partial exemption of the capital gain is similar to that shown in situation 2.
Example 2: Couple, the spouse staying at the family home passed away first
James and Amy were a couple and owned their family home jointly since they bought it in 1990. Amy moved into an aged care home in 2013.
James passed away first and Amy became the sole owner of their family home in 2015 while she was at the aged care facility at that time.
Amy passed away in 2017 and the family home was passed to her daughter Lucy. The family home has been rented out since James’s death.
When Lucy disposes of this property, different rules may apply to the original interest owned by James and Amy respectively.
The 50 per cent interest originally owned by Amy
This 50 per cent was Amy’s main residence and she was able to continue treating it as her main residence after she moved to the aged care home. As the period the property was used to produce income was less than six years, this 50 per cent interest would still be Amy’s main residence at the time of death.
If the property is sold within two years from Amy’s day of death, this 50 per cent interest would qualify for the full CGT exemption.
If the property is not sold within two years, only the partial exemption applies. Please refer to example 1, situation 2 for details.
The 50 per cent interest originally owned by James and passed to Amy in 2015
When James’ 50 per cent interest was passed to Amy, Amy was staying at the aged care facility. Amy never returned to the family home. It is not clear whether Lucy is entitled to the full exemption on selling this 50 per cent interest within two years of Amy’s death.
Many of the Australian Taxation Office’s (ATO’s) Private Binding Rulings (PBR) seem to suggest that even though Amy moved out of the property before she acquired James’ interest, she could continue treating this 50 per cent as her main residence under the absences rule.
Therefore, a full exemption would apply to this 50 per cent interest if the property is sold by Lucy within two years of Amy’s death.
On the other hand, some PBRs seem to suggest that because the 50 per cent interest inherited by Amy in the dwelling has never been her main residence during her ownership period from 2015 to 2017, the main residence CGT exemption does not appear to be available to Lucy.
When Lucy inherited this 50 per cent interest from Amy, she also inherited Amy’s cost base, which is the market value on James’ day of death. Any gain or loss Lucy makes upon disposal may not be disregarded under this interpretation.
Due to the ambiguities in this area, individuals should seek independent tax advice.
Summary
Rules around the main residence CGT exemption represent a meaningful financial advice opportunity. Advisers should work closely with tax specialists to achieve good financial outcomes for their clients and their clients’ beneficiaries.
As discussed above, the rules are very complicated. Individuals need to seek professional tax advice to confirm their CGT calculations and the correct application of the rules related to the main residence CGT exemption.
Linda Bruce is senior technical services manager at IOOF.
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