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For the purposes of the main residence exemption in Subdivision 118-B of the Income Tax Assessment Act 1997 (ITAA 1997), does the ownership period of a dwelling in a foreign country, include the period that it was owned by a taxpayer prior to their becoming an Australian resident?

Yes. For the purposes of the main residence exemption, the ownership period of the dwelling commences at the time prescribed in section 118-130 of the ITAA 1997. This means, in the circumstances of this case, that the taxpayer was entitled to a partial main residence exemption under section 118-185 of the ITAA 1997.

The taxpayer, an individual, was a resident in a foreign country. They acquired a dwelling in that country in 1995 which they used as their main residence before coming to Australia. The dwelling did not have the necessary connection with Australia during this time for the purposes of section 136-25 of the ITAA 1997.

The taxpayer became a resident of Australia during the 2001-02 income year.

The taxpayer sold the dwelling during the 2002-03 income year.

Broadly, if an individual owns land in a foreign country before they become a resident of Australia, only capital gains or capital losses that accrue in respect of the land after they become a resident are subject to the provisions of Parts 3-1 and 3-3 of the ITAA 1997.

Section 136-40 of the ITAA 1997 provides that if a taxpayer becomes a resident of Australia, assets that they own which do not have the necessary connection with Australia are taken to be acquired by them for market value at the time of becoming a resident.

In this case the taxpayer would make a capital gain if the capital proceeds from the sale of the dwelling exceeded the market value at the time they became a resident (assuming no other amounts had subsequently been included in the dwelling's cost base).

An issue arises as to whether the taxpayer is entitled to any main residence exemption for the capital gain, given that the dwelling was their main residence before they became an Australian resident. This depends on whether the acquisition rule in section 136-40 of the ITAA 1997 affects the calculation of the 'ownership period' referred to in Subdivision 118-B of the ITAA 1997.

In applying the main residence exemption, regard is had to a taxpayer's 'ownership period' of a dwelling and the number of days during that period that the dwelling was the taxpayer's main residence. A taxpayer has an ownership interest in land or a dwelling that they acquire under a contract from the time when they obtain legal ownership of it. Generally this happens when the contract is settled, unless the contract gives the taxpayer a right to occupy the dwelling at an earlier time. (subsection 118-130(2) of the ITAA 1997).

In this case, the taxpayer's ownership interest in the dwelling commenced in 1995. Section 118-130 of the ITAA 1997 is not modified in cases where a dwelling is taken to have been acquired at another time by a provision of the ITAA 1997.

If a dwelling is not a taxpayer's main residence for the entire ownership period, section 118-185 of the ITAA 1997 provides that a partial exemption is available. Provided all of the requirements in subsection 118-185(1) are satisfied, the taxpayer calculates their exemption using the formula in subsection 118-185(2).

Accordingly, the taxpayer, who after becoming a resident disposed of a dwelling that was their main residence before they became a resident, can claim a partial main residence exemption under section 118-185 of the ITAA 1997 as follows: Capital gain (calculated using MV acquisition cost) * (days in the ownership period that the dwelling was main residence \ total days in ownership period)

This view is consistent with that expressed in Taxation Determination TD 95/7. TD 95/7 provides that a taxpayer can make an election under the absence rule (now in section 118-145 of the ITAA 1997) for a dwelling that they owned before becoming a resident of Australia.