Update: changes to the CGT Main Residence Exemption
In a surprise announcement earlier this year, the Federal Government extended Australia’s foreign resident capital gains tax (CGT) regime by denying foreign and temporary tax residents access to the CGT main residence exemption.
Since then, the draft legislation has been released, and more details have emerged on how this exclusion will work.
Under the new rules, the main residence exemption will no longer be available to foreign-residents of Australia. The measure was announced as one of several initiatives designed to address housing affordability and was contained in this year’s Federal Budget.
While at the time, the announcement in the Federal Budget made specific mention to “temporary residents,” the exposure draft does not refer to individuals of this tax residency status, and only refers to Australian and foreign residents. As such, temporary residents are not affected by this change.
Transitional measures are included that will ensure existing properties held before 9 May 2017 will be grandfathered until 30 June 2019. However, the sale of an existing main residence by a foreign resident any time after this date will no longer be subject to the main residence exemption.
The proposed measure will not only affect individuals, but also trustees and individual beneficiaries of deceased estates and special disability trusts.
As foreign residents do not qualify for the 50% Capital Gains Tax discount, these individuals may be subject to tax rates of up to 45% on the entire sum of capital gains from the sale of a main residence.
Removal of Exemption
Individuals identified as foreign residents at the time of their dwelling’s sale will not be entitled to the main residence exemption to CGT. No apportionment is available if an individual has been an Australian resident for part of the ownership period. The test of residency is determined only at the time a CGT event applies to a main residence. The most common situation where a CGT event occurs is when there is a sale of a property, particularly when the contract for that sale is entered into.
The removal of the exemption will have significant consequences for expatriate Australians who wish to sell their main residence after losing or surrendering their Australian tax residency. The following example shows the impact on expatriate workers who have relocated overseas.
Vicki acquired a dwelling on 10 September 2010, moving into it and establishing it as her main residence as soon as it was practicable to do so. On 1 July 2018 Vicki vacated the dwelling and moved to New York. Vicki rented the dwelling out while she tried to sell it. On 15 October 2019 Vicki finally signs a contract to sell the dwelling with settlement occurring on 13 November 2019. Vicki was a foreign resident for taxation purposes on 15 October 2019.
The time of the CGT event for the sale of the dwelling is the time the contract for the sale was signed, that is 15 October 2019. As Vicki was a foreign resident at that time, she is not entitled to the main residence exemption in respect of her ownership interest in the dwelling.
This example shows that the outcome is not affected by Vicki previously using the dwelling as her main residence, or by the absence rule that could have otherwise applied to treat the dwelling as her main residence for the period 1 July 2018 to 15 October 2019.
Deceased Estates – the beneficiary is a foreign resident
The removal of the exemption will also have an impact on trustees and individual beneficiaries of a deceased estate. Generally, the benefit of the main residence exemption of the deceased person’s property can be passed on to the individual beneficiary where certain conditions are met.
If the deceased was an Australian resident for taxation purposes at the time of their death, then the main residence exemption accrued by the deceased for the dwelling continues to be available to the beneficiary.
However, if the beneficiary is a foreign resident, any additional component of the main residence exemption they accrue in their own right will be denied. In this situation, a pro-rata calculation based on the time of sale is required to determine the taxable capital gain when the beneficiary sells the dwelling.
Deceased Estate – the deceased is a foreign resident
If the deceased person was a foreign resident at the time of their death then the portion of the main residence exemption accrued by them is not available to the beneficiary.
The beneficiary continues to be entitled to the main residence exemption for any part of the exemption that they accrue in their own right.
The main residence exemption will not apply if the deceased person was a foreign resident at the time of death and the beneficiary that inherits the dwelling was also a foreign resident at the time the CGT event occurred. In this situation, the foreign resident beneficiary must account for the full capital gain arising from the sale of the dwelling.
What to do next
For Australian residents considering taking up employment opportunities overseas, careful planning is required to ensure that the impact on tax residency is fully considered and understood. For foreign resident individuals who have held their main residence in Australia since before 9 May 2017, the transitional period to 30 June 2019 may be accessible and they may be able to access the main residence exemption if a contract for the sale of the property is entered into before this date.
Foreign residents may wish to keep detailed records of non-deductible costs associated with their main residence to help maximise their cost base for the calculation of their capital gain.
Trustees and individual beneficiaries of deceased estates should review the taxation position of any residential property that is held by or inherited from such trusts, as the taxation position may now change significantly.
Ask your adviser for more advice around the main residence exemption.