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CGT Main Residence Exemption

The Main Residence CGT Exemption and how it now excludes Australian Expatriates

Introduction

The "main residence exemption" provides Australian taxpayers with an exemption from capital gains tax (CGT) where their property is, or has been, their family home, subject to meeting certain criteria. These long-standing provisions mean that capital gains made in relation to a qualifying main residence are typically exempt from Australian CGT; and that this exemption applies perpetually to properties that were never rented out, and for a further period of six years from when a property was rented out - this is called the "six year rule".

The exemption only applies where there is no other property nominated as a main residence and, when a property is re-occupied as a main residence, the six-year exemption period "resets".

Excluding Expatriates from July 1, 2020

On Wednesday, October 23, 2019 the Assistant Treasurer re-introduced legislation which had previously lapsed to:

"remove the entitlement to the CGT main residence exemption for foreign residents other than where certain life events occur during the period that a person is a foreign resident where that period is six years or less"

The previous legislation would have seen the proposed changes come into effect on 1 July 2019 - the new legislation had a new effective date of July 1, 2020 - and the definition of "foreign residents" above included Australian citizens and permanent residents living outside Australia and non-resident for Australian tax purposes..

The Bill passed the House of Representatives on Wednesday, November 27, 2019, and received Royal Assent, becoming law, on December 12, 2019. As a member of the Australian Tax Institute was quoted as saying, "There is no legitimate policy reason for denying Australian citizens the CGT main residence exemption in these circumstances". It is also unavoidable that many expats will sell properties unaware of these changes, with significant financial implications, while foreign expats resident in Australia on short term posting retaining access to the exemption.

The original draft legislation had been focussed on foreign investors in Australian real estate and despite later amendments, which removed temporary residents from the ambit of the legislation, the LNP government - with less enthusiastic support from the Labor - doggedly pursued the legislation in the full knowledge that the community most impacted would be Australian citizens and permanent residents based overseas, rather than "foreign investors".

Given the long delays and interruptions inherent with this legislation many expats hoped that it would simply disappear and be left to gather dust - loathe to have to sell family properties in Australia. However, when it became clear that the legislation would apply from July 1, 2020 many had a scant 6-9 months to sell their Australian property to avoid sometimes very significant tax losses. The Corona virus pandemic then intervened bringing the world, and the Australian real estate market, to almost a standstill and representing a near "perfect storm" for many expats.

This is an unnecessary, discriminatory piece of legislation pursued by a Government clearly of the view that expats, because they are "disenfranchised" from a voting perspective, can simply be ignored. Australian expatriate groups around the world should take a similar approach to Government representative when they seek assistance in the future; when "study tours" invariably restart after the Corona virus pandemic hopefully subsides.

A Summary of the Legislation

The Bill was accompanied by an Explanatory Memorandum (EM), and it summarises some of the key features and impacts of the proposed legislation as follows - and note that the potentially significant impact they can have on an Australian estate where the deceased is a non-resident, or a beneficiary is a non-resident.

Current Law - applicable from 1/7/2020 Previous Law
Main residence exemption: Individuals
Generally, individuals who are foreign residents at the time a CGT event occurs to a dwelling (or for a compulsory acquisition, a part of a dwelling) in which they have an ownership interest are not entitled to the CGT main residence exemption. However, individuals who have been foreign residents for a period of six years or less may be able to access the CGT main residence exemption if, during the period of that foreign residency, certain "life events" occurred. Individuals who are foreign residents are entitled to the CGT main residence exemption in the same way as individuals who are residents of Australia for taxation purposes.
Main residence exemption: Deceased is foreign resident at time of death
A trustee of a deceased estate is not entitled to the CGT main residence exemption in respect of an ownership interest in a dwelling of a deceased individual if the deceased was an excluded foreign resident at the time of death. A beneficiary of a deceased estate is not entitled to the portion of the CGT main residence exemption in respect of an ownership interest in a dwelling of a deceased individual if the deceased was an excluded foreign resident at the time of death. A trustee of a deceased estate is entitled to the CGT main residence exemption in respect of an ownership interest in a dwelling of a deceased individual who was a foreign resident at the time of death in the same way as if the deceased had been a resident at that time.A beneficiary of a deceased estate is entitled to the CGT main residence exemption in respect of an ownership interest in a dwelling of a deceased individual who was a foreign resident at the time of death in the same way as if the deceased had been a resident at that time.
Main residence exemption: Beneficiary of deceased estate is a foreign resident
A beneficiary of a deceased estate is entitled to the portion of the CGT main residence exemption in respect of an ownership interest in a dwelling of a deceased individual if the deceased was not an excluded foreign resident at the time of death. This applies even if the beneficiary is a foreign resident at the time a CGT event occurs to the dwelling. However, the beneficiary is denied any additional component of the main residence exemption that they are otherwise entitled to it in their own right if they are a foreign resident at the time a CGT event occurs to the dwelling. A beneficiary of a deceased estate is entitled to the CGT main residence exemption in respect of an ownership interest in a dwelling of a deceased individual if the beneficiary is a foreign resident in the same way as individuals who are residents of Australia for taxation purposes.

Just to summarise the main aspects of the legislation:

  • Individuals who sell their main residence and who were foreign residents at the time of disposal will not be entitled to the main residence exemption - this includes Australian citizens or permanent residents living overseas who were non-residents
  • For individuals, the date of the disposal of their interest in a property will generally be the time a contract for sale was entered into.
  • The Bill does not provide for any "apportionment" of the main residence exemption. This means that any days the dwelling had been owned as an Australian resident for Australian taxation purposes would be irrelevant in calculating any CGT liability,
  • The new legislation provides that a foreign resident may - unless they have been a foreign resident for more than 6 years - nevertheless be able to access the CGT main residence exemption if they satisfy the ‘life events test’ - applicable events include terminal illness, death and divorce.

We are unconvinced regarding the "life events test", and consider that it may be a political "sop", which will pose a number of practical problems and inequities. An example of how it is intended to apply is contained within the EM below:

Example 1.8 - Main residence exemption – life events test

Joan acquired a dwelling on 7 February 2015, moving into it with her spouse John and establishing it as their main residence as soon as it was first practicable to do so. Joan and John are residents of Australia at the time of the purchase of the property. In 2020 they retire to live in the Bahamas and acquire a new residence there. They become foreign residents at this time.They rent out their former Australian residence after they leave Australia and it is not maintained as their main residence in the rental period. In 2021 John dies and Joan decides to sell their former residence.

As Joan has been a foreign resident for less than six years at the time of entering into the CGT event for the sale and her spouse has passed away during the period of her foreign residency, she is entitled to a partial main residence exemption for the sale of the residence based on the period that it was her main residence.

Clear Inequities

In effect, the timing of any sale would be a crucial concern, and to illustrate just how inequitable and extreme those timing issues could be, consider Example 1.2 provided in the Explanatory Memorandum below - and note that this Example is almost a complete copy of that which accompanied the original (lapsed) legislation nearly 2 years earlier.

Example 1.2 - Main residence exemption denied

Vicki acquired a dwelling in Australia on 10 September 2010, moving into it and establishing it as her main residence as soon as it was first 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 15October2020Vicki finally signs a contract to sell the dwelling with settlement occurring on13 November 2020. Vicki was a foreign resident for taxation purposes on 15 October 2020. The time of CGT event A1 for the sale of the dwelling is the time the contract for sale was signed, that is 15 October 2020. 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.

Note: This outcome is not affected by

  • Vicki previously using the dwelling as her main residence; and
  • the absence rule in section 118 - 145 that could otherwise have applied to treat the dwelling as Vicki’s main residence from 1 July 2018 to 15 October 2020 (assuming all of the requirements were satisfied).

This example demonstrates that the Government remains comfortable with policies which introduce significant "cliff" effects, and to blithely penalise individuals who move internationally rather than domestically for work or personal reasons. Remember in this context that any capital gain which occurs whilst you are non-resident will attract "non-resident" tax rates - which start at 32.5% with no tax free allowance.

And what about the option of simply returning to Australia, re-establishing yourself as a resident, and then selling the property - and thereby qualifying for the main residence exemption?

Rather extraordinarily, Paragraph 1.24 of the Explanatory Memorandum to the Act indicates that the general anti-avoidance rules in Part IVA may apply to arrangements that have, "been entered into by a person for the sole or dominant purpose of enabling that person or another person to obtain the [main residence exemption]". How this would apply in practice is hard to understand; there is no prescribed period that an individual would need to return to Australia in order to re-establish residency, it is determined on the facts.

Going Forward

We have always supported the continued investment by Australian expatriates in Australian residential property because it represents both a hedge against movements in the local Australian real estate market and adverse currency movements. These proposed recent changes, together with the withdrawal of the 50% CGT discount for non-residents in 2012, will however significantly impact any analysis of whether property should continue to be held in Australia.

For expats aged 65 years of age and over selling their Australian main residence, remember that it has been possible since June 30, 2018 to make "downsizer" contributions of up to $300,000 each into superannuation - subject to meeting certain eligibility requirements. This may introduce significant flexibility in a very small number of situations, given recent restrictions on making super non-concessional contributions.

In summary, the Government effectively continues to support domestic mobility, and the position of temporary residents, while penalising international mobility for its own citizens. It is quite obvious that all the major parties continue to work on the basis that there are "no votes" in the Australian expatriate community. From a practical perspective, all the Australian expatriates maintaining a main residence property in Australia should consider their position in detail regarding the disposal, or otherwise, of this property, in concert with their tax advisor - and no sale should be made without comprehensive tax advice.

If you would like to arrange professional advice please complete the Inquiry form below providing details and you will be contacted promptly.