Noose is tightening on property holders

First there were the changes in the deductibility rules for property investors. Travel claims for certain investors were no longer deductible. Property investors can no longer claim rental property travel expenses incurred while inspecting, maintaining or collecting rent from rental properties.

Loss of deduction for travel became law from the 1st of July 2017 and despite this the ATO is still finding that many taxpayers continue to claim travel expenses in defiance of the law.

Ignorance of the law change or deliberate, it is too early to speculate. 

At the same time, income tax deductions for the decline in value of “previously used” or “second hand” depreciating assets were also made. You can no longer claim a deduction for decline in value for used assets from 1 July 2017 unless either:

• the previously used asset was acquired under a contract entered into prior to 7.30 pm on 9 May 2017; or
• the asset was acquired prior to 1 July 2017 and the entity was not entitled to a deduction e.g. it was not used to earn income.

The effect of the amendments is the investor will only be allowed to deduct the decline in value of depreciating assets if the asset is acquired new.

Secondly, the government has changed the law around deductibility of expenses such as council rates and interest connected with vacant land.

This change applies from 1 July 2019, irrespective of when the property was purchased. Investors can no longer claim holding cost on vacant land where the intention was to construct new residential premises. Holding cost denied could be applied to the cost base of the land for CGT purposes.  

The third change relates to the capital gains tax rules for foreign residents. 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.

The main residence exemption disregards a taxpayer’s capital gain or loss for CGT purposes if the taxpayer is an individual and the dwelling was the taxpayer’s main residence throughout the ownership period. The main residence exemption also provides a partial exemption if the dwelling was the taxpayers main residence for only part of the ownership period.

The main residence can also apply to an individual who is a beneficiary of a deceased estate, where the deceased person used the dwelling as a main residence.

The government has now enacted changes to the CGT tax rules 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. This change applies from 9 May 2017, however transitional relief for the main residence exemption applies to 30 June 2020.

If the home was acquired before 9 May 2017, the main residence exemption will apply if the sale happens on or before 30th June 2020 and the normal eligibility criteria under the main residence exemption have been satisfied. If the sale happens on or after 1 July 2020, the new rules will apply. If the property was acquired on or after 9 May 2017, the new rules will apply regardless of when the property is sold.

If the property was acquired before 20 September 1985, it will still be pre-CGT asset which will not create a CGT liability if sold in any case.

If you are an Australian tax resident at the time of selling your main residence, you will not be affected by the change. Also, Australian residents will not be affected even if they become a foreign resident while owning their main residence, as long as they re-establish Australian tax residency and are an Australian tax resident at the time, they sell their main residence (CGT event A1). CGT event A1 occurs at the time a contract is entered into and this is the critical date. As a result of the change unless the foreign resident takes advantage of the transitional relief, affected foreign residents need to recognize a capital gain or loss that arises from the CGT event.

One issue that comes to mind is all the holding cost and capital improvements to the property since acquisition. Can the taxpayer recall and more importantly, kept documents to substantiate these outgoings as they can increase the cost base for CGT purposes, so long as you were not deriving income from the property. For CGT purposes, non-deductible holding costs such as repairs, rates, insurance and interest on a loan to acquire the property can be added to the cost base to calculate the capital gain on the property.

There is however a carve out if an individual has been a foreign resident for a continuous period of six years or less if certain life events occur during their period of foreign residency.

Life events that can enable the foreign resident to access the main residence exemption are as follows:

1. Terminal medical condition – either you, your spouse, or their child who was 18 years of age had a ‘terminal medical condition’
2. Death – your spouse or child under the age of 18 dies
3. Divorce or separation – the sale of the home involved the distribution of assets between you and your spouse as a result of divorce, separation or similar maintenance agreements.

If one of these life events occur at the time of the CGT event to a foreign resident who has been a foreign resident for a continuous period of six years or less, then the person may be still able to access main residence exemption.

The six-year absence rule will not help a foreign resident access the main residence exemption.

Under the six-year rule, a property can continue to be exempt from CGT if sold within six years of first being rented out. The exemption is only available where no other property is nominated as the main residence. When the dwelling is reoccupied as the main residence, the six-year exemption resets. This absence rule that could otherwise have applied is disregarded if at the time of sale, the individual is a foreign resident. 

An example extracted from explanatory memorandum to the Bill changing the CGT main residence rules (Treasury Laws Amendment (Reducing Pressure on Housing Affordability MEASURES) Bill 2019) illustrates this point:

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 15 October 2020 Vicki finally signs a contract to sell the dwelling with settlement occurring on 13 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).

The CGT main resident exemption change comes on top of foreign resident capital gains tax withholding regime. The foreign resident capital gains tax withholding regime has been quite successful since its introduction. The withholding regime requires purchasers of certain Australian property that has a market value of $750,000 or more to withhold 12.5 per cent of the purchase price and pay it to the ATO, if they purchase the asset from a foreign resident.

Whilst property investors dodge the negative gearing bullet, there has been a raft of other changes that tax practitioners need to be on top of in order to manage clients’ property affairs.

Tony Greco FIPA, general manager of technical policy, IPA