Downsizer contribution rules and strategies
Since its introduction in the second half of 2018, the downsizer contribution strategy continues to be popular with both advisers and their relevant client base. It allows those who are age 65 or over and have sold a qualifying residence to contribute up to $300,000 each of the sale proceeds into superannuation outside the contribution rules and limits which may otherwise preclude them from doing so.
For a seemingly straightforward strategy, it also generates its fair share of questions from advisers. In this article we will highlight some of the relevant rules and strategies.
Key highlights and attractions of the strategy include:
- The ability for those age 67 or more to contribute to super without having to meet the work test – there is no upper age limit;
- The downsizer contribution can be made irrespective of the client’s total super balance (TSB) which might otherwise limit or exclude the client from making non-concessional contributions (NCCs);
- The downsizer contribution can be made in addition to NCCs where the client is otherwise eligible to make these; and
- The downsizer contribution counts towards the client’s tax-free super component.
- Limitations and issues to consider with the downsizer contribution strategy include:
- Although a contribution can be made to super, it can only be moved to a tax-exempt retirement phase pension if the client has sufficient space in their personal (pension) transfer balance account; and
- The proceeds from sale of the clients’ Centrelink exempt asset (their home) may become assessable by Centrelink and this may lead to a reduction in Age Pension (or other benefit) eligibility.
KEY RULES AND ELIGIBILITY CRITERIA
Eligibility criteria to make a downsizer contribution include:
- Eligible sale contracts are entered into on or after 1 July, 2018;
- Sale proceeds must come from the sale/disposal of a dwelling (or interest in the dwelling) which is eligible for at least a partial main residence capital gains tax (CGT) exemption (or if the dwelling is a pre-CGT asset it would otherwise meet that requirement);
- The home being sold must be in Australia and cannot be a caravan, houseboat or mobile home;
- The property must have been owned by the client and/or their partner for at least ten years;
- The client(s) making a downsizer contribution must be at least age 65 when the contribution is made;
- The contribution must be made within 90 days of receipt of the sale proceeds (usually settlement);
- The contribution must be accompanied by a ‘Downsizer contribution into super’ form available from the super fund or the Australian Taxation Office (ATO);
- The maximum permitted downsizer contribution is the lesser of:
- a maximum of $300,000 per person from the sale of one qualifying property; or
- limited to the amount of sale proceeds (if less than $600,000). The term ‘sale proceeds’ is the gross sale price; and
- The client has not previously made a downsizer contribution from the sale proceeds of another home.
A proposal in the 2021 Federal Budget, if legislated, will decrease the minimum age for the downsizer contribution to age 60.
Let’s investigate the eligibility criteria in a bit more detail.
DOWNSIZER DOESN’T HAVE TO BE ‘DOWNSIZER’
Despite the name, there is no requirement that the vendors buy another residence. Selling a qualifying residence is a key element here. The vendors could be moving to another property they already own, buying something bigger and more expensive, renting, going to a retirement village, aged care, living with adult kids or going on extended travel.
DISPOSAL OF AN ‘OWNERSHIP INTEREST’
The most common downsizer contribution we see is following the normal arm’s-length sale of the clients’ residence. It certainly includes sale of a ‘strata title’ unit and even company title apartments. However, the definition of an ownership interest is potentially wider than common ‘outright ownership’. It includes disposal of only part of an ownership share in the property or even disposal of a ‘licence’ or ‘right to occupy’.
Specific tax advice may be required in these situations. It could include disposal of a retirement village interest, depending on the nature of the ‘ownership’ or terms of occupation.
MAIN RESIDENCE CGT EXEMPTION
The dwelling that has been sold must be eligible for at least a partial main residence CGT exemption. This basically requires that an eligible contributor must have occupied the dwelling as their main residence at some time. This includes a member of the couple who is not an owner (i.e. not on title). The dwelling could have been used as an investment property by the clients at some stage but as long as it was also used as their residence it could also qualify for the main residence CGT exemption (at least in part).
If the dwelling is a pre-CGT asset (i.e. acquired prior to 20 September, 1985) then it would have to qualify as the contributor’s main residence as if it was a post-CGT asset as above.
A property that has ‘mixed use’ could also qualify. Take for example, the sale of a farm. The dwelling on the farm may qualify for the main residence exemption and if so the whole of the farm sale proceeds are eligible to be downsizer contribution(s) up to the $300,000 per person cap – there is no requirement to apportion sale proceeds between the dwelling and the rest of the property.
Where clients have more than one dwelling which could qualify for the main residence CGT exemption (in whole or part) they need to consider where their own best outcome might be.
Broadly, they don’t have to make the election to apply the exemption until they sell a qualifying property. Claiming the exemption on one property and making the downsizer contribution could deny them the ability to apply the exemption to another property and lead to a worse CGT outcome. Specific tax advice may be required in such a situation.
TEN-YEAR OWNERSHIP REQUIREMENT
The property must have been owned for at least 10 years. Where a current owner has not been on title for the whole 10 years then periods of ownership by a former spouse of the current owner can count towards this period. The relationship with the former spouse may have ended, for example, due to death or relationship breakdown.
It is sufficient that one member of the couple meets the 10-year ownership requirement for both members of the couple to be eligible (other criteria being met).
Where there has been a property construction or ‘knock-down re-build’ it is sufficient that the underlying land has been owned for at least ten years.
The ATO counts the minimum 10-year period from settlement to settlement (which may differ from CGT rules where a ‘contract date’ is often the relevant date).
CONTRIBUTION LIMITED BY SALE PROCEEDS
Each member of the couple may contribute up to $300,000 each from the sale proceeds (basically the gross sale price).
Where the sale price is less than, say, $600,000 then the couple are limited to contributing an amount equal to the gross sale price (‘capital proceeds’), and no more than $300,000 for either of them. This applies even if the couple has other funds available to contribute up to the limit.
This limit also applies where the disposal has been made at less than market value, for example, to a related party. Expenses associated with the sale, e.g. agent’s commission and legal fees and possibly repayment of a loan do not reduce the ‘gross sale price’ for the purposes of determining the maximum available downsizer contribution.
CONTRIBUTION WITHIN 90 DAYS OF RECEIVING SALE PROCEEDS
A key requirement is that the downsizer contribution is made within 90 days of receiving the sale proceeds. It is possible to apply to the ATO for an extension of this 90-day period.
The explanatory memorandum indicates that an extension will not be granted to allow a contributor to reach the age 65 qualifying age to make the contribution.
If the contribution does not qualify
A super fund will accept a contribution as a downsizer when it is accompanied by the election form completed by the contributor. The ATO may subsequently notify a super fund that the contribution does not qualify as a downsizer, for example, because the minimum 10-year ownership requirement has not been met (the ATO checks this through data matching of state Land Titles/Registry records).
When the super fund is notified that the ‘downsizer contribution’ has been found to be ineligible the fund must assess whether it could otherwise accept the contribution from the member. This includes an assessment of the client’s contribution eligibility e.g. age and work test. The member may also be able to subsequently supply the ATO with information to confirm the eligibility of the downsizer contribution.
If the fund determines that it can accept the contribution it will be assessed against the client’s NCCs cap. This may lead to an excess NCCs assessment by the ATO. If the fund determines that it cannot accept the contribution (or part) from the client then the fund must return the contribution (or part) to the client within 30 days.
STRATEGY OPPORTUNITIES
Where it is possible for the client to commence a tax-exempt retirement phase pension this should be done as a separate pension from other pension(s) (probably containing taxable component) that the client may have. The pension commenced solely with the downsizer contribution will be 100% tax-free component which could be useful for estate planning purposes where adult children are death benefit beneficiaries.
Releasing home equity by sale of the client’s residence will likely create a Centrelink assessable asset which could reduce or eliminate eligibility for Age Pension or other benefits the client may previously have been receiving. Ideal clients for a downsizer funded pension may be self-funded retirees who may already be paying marginal rate tax on retirement income and have the ability to move the downsizer to a tax-exempt retirement phase pension.
John Perri is technical super manager at AMP.
Recommended for you
When entering paid employment, it’s not long before we are told that we’ll need to lodge a tax return but there are times when a person will be excepted.
Anna Mirzoyan examines how grandfathering affects income support payments and how factors such as paying for aged care can impact them.
There are specific requirements that only apply to trustees of self-managed superannuation funds, writes Tim Howard, including the allocation in their investment strategy.
Investments bonds offer a number of flexible, tax-advantaged benefits, writes Emma Sakellaris, but these are often overlooked as old fashioned when it comes to portfolio allocations.
