1 If H and W move back into the property located at ADDRESS A and rent out the property located at ADDRESS B for market value rent which they declare as assessable income, for a period of not longer than six years (including any period where the property is left vacant while advertised for rent), can H and W claim as a deduction the interest charged on the mortgage over ADDRESS B for the period the property is rented out?
Yes Question 2 If the answer to question 1 is yes, if H and W move into the new dwelling built at ADDRESS B as soon as practical following the completion of construction, will H and W remain entitled to a full main residence exemption in accordance with Subdivision 118-B of the Income Tax Assessment Act 1997 on the eventual sale of the new dwelling built at ADDRESS B? Answer Yes Question 3 If H and W elect to treat ADDRESS B as their main residence from the time of purchase, will the interest charged on the mortgage over the property located at ADDRESS A, the ADDRESS A Council rates and water rates; incurred from the time H and W purchased ADDRESS B, form part of the third element of the cost base of ADDRESS A in accordance with subsection 110-25(4) of the Income Tax Assessment Act 1997 , where the costs were not deductible in the year they were incurred? Answer Yes This ruling applies for the followings: For a number of years commencing in the year ended 30 June 20XX The scheme commenced on: In the year ended 30 June 20XX
1. H and W are both Australian residents for tax purposes and are married to each other. 2. H and W purchased the property located at address, ADDRESS A (Property A) in MMYY as joint tenants. 3. Upon purchasing Property A, H and W occupied it as their home and considered it to be their main residence for tax purposes. 4. The purchase of the property was financed by a mortgage. The mortgage currently still exists over the property. The interest accruing in relation to the mortgage over Property A is currently offset by savings in a linked offset account and as a result, H and W are currently not paying interest towards the mortgage, however the mortgage has not been repaid, discharged or refinanced. 5. On DDMMYY, H and W purchased the property located at ADDRESS B (Property B) for $XX as joint tenants. 6. Property B is 100% financed by a mortgage over the property. 7. Shortly after, and as soon as practical following settlement of Property B, H and W moved into Property B to live as their main residence.
8. In MMYY, members of H and W's extended family moved into Property A for a period of less than 12 months. 9. The extended family living in Property A did not pay rent to live in Property A and have since moved out. 10. H and W intend to knockdown Property B and build a new home in its place. They intend to commence the knockdown and build process at Property B in the 20ZZ calendar year. 11. Following the construction of the new home at the Property B location, H and W intend to move into the newly constructed home at the Property B location as their main residence and remain living there as their main residence for a long term, an indefinite period of time, which will at least exceed three months. 12. The period of time from when Property B is last occupied and the time the new dwelling is constructed on the Property B location and becomes H and W's main residence, will not exceed four years.
13. In the 20XX calendar year (and possibly 20ZZ calendar year), while they are planning the build of the new home at the Property B location and waiting for council approval to commence construction, H and W intend to move back into Property A and rent out Property B to an unrelated third party for market value rent. The rental income earned will be declared as assessable income on their relevant income tax returns. 14. H and W intend to rent Property B for a period of approximately 12 months. That 12-month period may increase if the demolition and construction commencement date is delayed, but the total time the property will be rented out (including any period the property is advertised for rent) will not exceed six years. 15. Once H and W have moved into the new home at the Property B location, H and W intend to sell Property A.
16. During the period that H and W return to living in Property A, while Property B is rented out and during the demolition and construction of Property B, H and W expect to spend some or all of the funds that are currently offset against the Property A mortgage and expect that interest will then be charged on the Property A loan. 17. H and W have continued to pay the Property A council and water rates since the purchase of Property B.
Income Tax Assessment Act 1997, section 6-10 Income Tax Assessment Act 1997, section 8-1 Income Tax Assessment Act 1997, section 102-5 Income Tax Assessment Act 1997, section 102-20 Income Tax Assessment Act 1997, section 103-25 Income Tax Assessment Act 1997, section 104-10 Income Tax Assessment Act 1997, section 108-5 Income Tax Assessment Act 1997, section 110-25 Income Tax Assessment Act 1997, section 118-110 Income Tax Assessment Act 1997, section118-145 Income Tax Assessment Act 1997, section 118-150 Income Tax Assessment Act 1997, section 118-190
Issue 1 All legislative references are references to the Income Tax Assessment Act 1997 (ITAA 1997)unless otherwise stated. Question 1 Detailed reasoning Section 8-1 allows an individual taxpayer, who is not in business, to deduct all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, relate to the earning of exempt income or are prevented by a provision of the ITAA 1997: General deductions (1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income. Note: Division 35 prevents losses from non - commercial business activities that may contribute to a tax loss being offset against other assessable income. (2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or
(b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your * exempt income or your * non - assessable non - exempt income; or (d) a provision of this Act prevents you from deducting it. Therefore, for a taxpayer to be able to claim the interest charged on a mortgage as a deduction, the interest must be incurred in gaining or producing the taxpayer's assessable income. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith (TR 95/25), discusses the Commissioner's view regarding the principles governing the deductibility of interest expenses.
Paragraph 3 of TR 95/25 explains that whether a loss or outgoing incurred by a taxpayer satisfies the requirements of section 8-1 is dependent on all the facts relating to the loss or outgoing and, in particular, that there must be a sufficient connection between the interest expense and the activities which produce assessable income and that it is necessary to consider the objective circumstances of the use to which the borrowed funds are put by the borrower as well as the objective purpose of the borrowing. Generally, when a taxpayer takes out a mortgage to purchase a property and interest is charged on that loan, where the taxpayer is earning assessable income by renting out the property, they can claim the interest as a deduction. The property must be rented or genuinely available for rent in the income year in which the deduction is claimed, and a deduction cannot be claimed for interest expenses incurred where the taxpayer uses the property for private purposes, or where the taxpayer uses the loan for private purposes.
In MM 20YY H and W purchasedthe property located at ADDRESS B (Property B) and moved in as soon as practicable after settlement and intentionally treated Property B as their main residence. Property B is 100% financed by a mortgage over the property. H and W intend to demolish Property B and build a new dwelling on that land. In the 20XX calendar year H and W intend to move back into the property located at ADDRESS A (Property A) and rent out Property B for market value rent while they plan their new build and prepare to demolish Property B. They will declare the rental income as assessable income and will rent Property B for a period of less than six years (including any period where the property is left vacant while advertised for rent). H and W can claim as a deduction the interest charged on the mortgage over Property B for the period the property is rented out. The interest charged on the mortgage has the relevant nexus to the earning of the rental income to allow them to claim the interest as a deduction under section 8-1. Question 2 Detailed reasoning
Under section 6-10, assessable income includes statutory income. Capital gains are included as assessable income under section 102-5. In accordance with section 108-5 both Property A and Property B are Capital Gains Tax (CGT) assets, of which H and W each hold a 50% interest. Where two or more individuals own a CGT asset jointly, CGT applies separately to each individual's interest in the asset. A capital gain or capital loss is made if a GCT event happens to a CGT asset (section 102-20), with CGT event A1 occurring when a taxpayer disposes of their ownership interest in a CGT asset (section 104-10). That is, CGT event A1 will occur in relation to H and W's interest in Property A and Property B when they dispose of their interests in those properties A taxpayer is considered to have disposed of a CGT asset if a change of ownership occurs. The capital gain or capital loss is made at the time of the event (s 104-10). Main residence exemption
Section 118-110 provides that an individual can generally disregard a capital gain or loss from a CGT event that happens to their ownership interest in a dwelling that was their main residence throughout their ownership period, where the interest did not pass to them as a beneficiary in the estate of a deceased person and the dwelling has not been used to produce assessable income (with some exceptions). To access the main residence exemption, a choice or election is not required to be made in advance, even where one dwelling ceases to be a taxpayer's main residence and another is acquired and occupied. The 'choice' is effectively made by the taxpayer when they prepare their income tax return in the relevant year by excluding the capital gain (section 103-25).
Section 118-190 provides that generally a taxpayer will only be entitled to a partial main residence exemption if the dwelling was used to produce assessable income during the ownership period. However, subsection 118-190(3) states that a taxpayer can ignore any use of the dwelling for the purpose of producing assessable income during any period that they continue to treat it as their main residence under section 118-145 (about absences), to the extent that any part of it was not used for that purpose just before it last ceased to be their main residence.
Section 118-145 about absences, extends the main residence exemption by allowing a taxpayer to choose to continue to treat their main residence as their main residence during a subsequent period of absence. The dwelling must first qualify as the taxpayer's main residence before the absence concession can apply (s118-145(1)) and no other dwelling can be treated as the taxpayer's main residence during the absence (except where section 118-140 applies, section 118-145(4)). Where the dwelling that was the taxpayer's main residence is used for the purpose of producing assessable income (for example through renting the dwelling to a third party), the maximum period of time that a taxpayer can treat it as their main residence while being absent from the dwelling and using it to produce assessable income is 6 years, whereas the exemption will apply for an unlimited period where the dwelling is not used to produce income in the period of absence (subsections 118-145(2) - 118-145(3)). Section 118-145 states: 118-145(1) If a *dwelling that was your main residence ceases to be your main residence, you may choose to continue to treat it as your main residence. 118-145(2)
If you use the part of the *dwelling that was your main residence for the *purpose of producing assessable income, the maximum period that you can treat it as your main residence under this section while you use it for that purpose if 6 years. You are entitled to another maximum period of 6 years each time the dwelling again becomes and ceases to be your main residence. 118-145(3) If you do not use the *dwelling for that purpose, you can treat it as your main residence under this section indefinitely. 118-145(3A) This section does not apply if the *dwelling was your main residence because of section 118-147 and ceases to be your main residence because of subsections 118-147(3) and (4). 118-145(4) If you make the choice, you cannot treat any other *dwelling as your main residence while you apply this section, except if section 118-140 (about changing main residences) applies. Example You live in a house for 3 years. You are posted overseas for 5 years and you rent it out during your absence. On your return you move back into it for 2 years. You are then posted overseas again for 4 years (again renting it out). You then move back into it for 3 years, after which you sell the house.
You have not treated any other dwelling as your main residence during your absences. You may choose to continue to treat the house as your main residence during both absences because each absence is less than 6 years. You can make this choice when preparing your income tax return for the income year in which you sold the house. Where a taxpayer builds a dwelling on land they already own, generally the land does not start to qualify for the main residence exemption until the dwelling actually becomes the taxpayer's main residence. However, section 118-150, about building, renovating or repairing a dwelling, extends the exemption by allowing a taxpayer to choose for the main residence exemption to apply to land for up to four years before the dwelling becomes their main residence. They can only make this choice if the dwelling becomes their main residence as soon as practicable after the building work is finished and then continues to be their main residence for a minimum of three months. Section 118-150 states: Section 118-150 If you build, repair or renovate a dwelling 118-150(1)
This section applies to land in which you have an *ownership interest (except a life interest) if you build a *dwelling on the land, or repair, renovate or finish building a dwelling on the land. 118-150(2) You can choose to apply this Subdivision as if the *dwelling that you are building, repairing or renovating on the land were your main residence from the time you *acquired the *ownership interest. 118-150(3) You can make the choice only if: (a) a *dwelling on the land that you construct, repaid or renovate become your main residence (except because of section 118-147) as soon as practicable after the work is finished; and (b) it continues to be your main residence for at least 3 months. 118-150(4) There is a time limit during which the choice can operate. This is the shorter of: (a) 4 years, or a longer time allowed by the Commissioner, before the *dwelling becomes your main residence; and (b) the period starting when you *acquired your ownership interest in the land and ending when the dwelling becomes your main residence. 118-150(5)
If there was already a *dwelling on the land when you *acquired your *ownership interest and you or someone else occupied it after that time, the period in subsection (2) and paragraph (4)(b) starts when the dwelling ceased to be occupied. 118-150(6) Once you make the choice, no other *dwelling can be treated as your main residence during the period referred to in subsection (4), except if section 118-140 (about changing main residences) applies. ATO Interpretive Decision ATO ID 2003/232 Income Tax Capital gains tax: main residence exemption - demolition and reconstruction of dwelling (ATOID 2003/232) and ATO Interpretive Decision ATO ID 2006/185 Income tax Capital gains tax: main residence exemption - choice to treat demolished dwelling as main residence (ATO ID 2006/185) discuss how choices can be made under sections 118-145 and 118-150 and how the two provisions can operate together. [1]
ATO ID 2003/232 confirms that if a taxpayer builds a dwelling to replace a demolished main residence and makes a choice under section 118-150 to treat the land on which the new dwelling is constructed as the taxpayer's main residence from the time that the demolished dwelling was last occupied by the taxpayer, and there is not more than four years between the time the demolished dwelling was last occupied and the time the new residence became the taxpayer's main residence, then the two dwellings may be treated as one and the main residence usage of the original dwelling will count towards the main residence exemption of the new dwelling and land as if there is an unbroken period of main residence occupancy.
ATO ID 2006/185 considers the additional circumstance of a taxpayer making a choice under section 118-145 in addition to the choice under 118-150 when considering whether the taxpayer can be entitled to a full main residence exemption on the sale of a dwelling built to replace a dwelling that was always the taxpayers main residence, even where the original dwelling was occupied by the taxpayer for only part of the time they owned it. In ATO ID 2006/185 the taxpayer purchased a dwelling and resided in that dwelling as their main residence. They then moved out and rented that dwelling out for a period of time but chose to continue to treat the dwelling as their main residence during that period. The taxpayer then demolished the dwelling and built a new dwelling that they moved into as their main residence. ATO ID 2006/185 states:
Subsection 118-145(1) of the ITAA 1997 allows the taxpayer to make a choice that a dwelling continues to be treated as their main residence even though it has ceased to be so. The choice can be made for a total of six years where the dwelling was used for the purpose of gaining or producing assessable income, or indefinitely where it was not used for this purpose. In this case, the taxpayer chose to treat the original dwelling as their main residence from the time they stopped living in the dwelling to the time the dwelling was demolished. The effect of making the choices under sections 118-145 and 118-150 of the ITAA 1997 in these circumstances, will be that there is taken to be an unbroken period of main residence occupancy on the land from the time the original dwelling became the taxpayer's main residence in late 1996, until the new dwelling was sold in late 2004.
H and W purchased Property B in MM 20YY and moved into Property B to live as their main residence. H and W intend to knockdown Property B and build a new home in its place. They intend to commence the knockdown and build process at Property B in the 20ZZ calendar year. Following the construction of the new home at the Property B location, H and W intend to move into the newly constructed home at the Property B location as their main residence and remain living there as their main residence for a long term, indefinite period of time, which will at least exceed three months. In the 20XX calendar year (and possibly 20ZZ calendar year), while they are planning the build of the new home at the Property B location and waiting for council approval to commence construction, H and W intend to move out from Property B and rent out Property B to an unrelated third party for a period of approximately 12 months (this period may increase but will not exceed six years). H and W intend to continue treating Property B as their main residence from the time of purchase and throughout any period of absence (while renting Property B out or while demolishing Property B and building the new dwelling on the Property B land). H and W will not treat Property A or any other property as their main residence during this period. If H and W move into the new dwelling built at the Property B location and live there for at least three months they are entitled to make choices under sections 118-145 and 118-150 will remain entitled to a full main residence exemption in accordance with Subdivision 118-B on the eventual sale of the new dwelling built at ADDRESS B as the choices will effect an unbroken period of main residence occupancy on the land from the time Property B became H and W's main residence.
Question 3 Detailed reasoning For most CGT events the cost base of the CGT asset is needed to work out whether a taxpayer has made a capital gain. The cost base of an asset consists of 5 elements (subsection 110-25(1)) and is generally the cost of the asset when the taxpayer purchased it in addition to other costs associated with acquiring, holding and disposing of the asset. Subsection 110-25(4) provides that the third element of the cost base of a CGT asset is generally the costs of owning the CGT asset and states: 110-25(4) The third element is the costs of owning the *CGT asset you incurred (but only if you *acquired the asset after 20 August 1991). These costs include: (a) interest on money you borrowed to acquire the asset and (b) costs of maintaining, repairing or insuring it; and (c) rates or land tax, if the asset is land; and (d) interest on money you borrowed to refinance the money you borrowed to acquire the asset; and (e) interest on money you borrowed to finance the capital expenditure you incurred to increase the asset's value.
Expenditure on assets acquired after 7:30 pm on 13 May 1997 does not form part of the third element of the cost base to the extent that they have been deducted or can be deducted by the taxpayer (and subsection 110-45(1B)). Property A was acquired by H and W after 20 August 1991. Property A has not been used to produce assessable income, and from the time that H and W purchased Property B, they no longer considered Property A to be their main residence. The interest charged on the mortgage over Property A and the Property A Council rates and water rates, incurred from the time H and W purchasedProperty B were not and could not have been deducted by H and W. That interest charged on the mortgage over Property A and the Property A Council rates and water rates are considered to be costs of owning Property A and will form part of the third element of the cost base of Property A in accordance with subsection 110-25(4). > [1] ATO ID 2003/232 and ATO 2006/185 have been withdrawn as guidance on the basis of their decisions is contained in the Guide to capital gains tax.