Taxing Times Ahead – The Removal of the CGT Main Residence Exemption for Australian Expats

On 12 December 2019, the Australian Government introduced legislation that removed the Capital Gains Tax (CGT) main residence exemption for foreign residents.

A foreign resident is an individual who is not a resident for Australian tax purposes.

This will impact individuals who are going, or who are already, overseas and who sell their Australian main residence while a tax non-resident of Australia.

This change along with the previous removal of the 50% CGT discount for non-residents back on 8 May 2012 will significantly impact any analysis of whether property should continue to be held in Australia.

For many Australian Expats the removal of the CGT main residence exemption may force them into making decisions such as selling their homes much earlier than planned or deferring the sale of their main residence until they eventually return to Australia.

Background

Previously, individuals were generally not subject to CGT on the sale of a dwelling that they treated as their main residence. If the home was their main residence for only part of the ownership period, or if the dwelling was used to produce income (for example, rented out the property), then a partial exemption may be available.

In addition, if the individual moved out of the dwelling and did not claim another property as their CGT main residence, they could continue to treat the dwelling as their CGT main residence for a period up to six years if they rented it out and derived rental income (the 6 year absence rule), or indefinitely if they did not rent the dwelling out and derived no income.

The main residence exemption was available to individuals who were residents, foreign residents, and temporary residents for tax purposes.

When do the changes apply?

The changes apply to foreign residents for tax purposes as follows:

For property held prior to 7.30pm (AEST) on 9 May 2017:

• The CGT main residence exemption can only be claimed for disposals that occur up until 30 June 2020 and only if they meet other requirements for the exemption (known as the transitional provisions).
• Disposals that occur from 1 July 2020 onwards will no longer be entitled to the CGT main residence exemption unless certain life events (see exception below) occur within a continuous period of six years of the individual becoming a foreign resident for tax purposes.

For property acquired at or after 7.30pm (AEST) on 9 May 2017:

• The CGT main residence exemption no longer applies to disposals from that date unless certain life events (see exception below) occur within a continuous period of six years of the individual becoming a foreign resident for tax purposes.

What are the impacts of these changes?

1. If a foreign resident sells their main residence they may be subject to CGT on the sale where previously they could access a full or partial main residence exemption.
2. An individual who ceases to be an Australian tax resident cannot have the benefit of the absence rule for any period of their ownership period (known as the 6-year absence rule).
3. The special cost base reset rules under s118-192 (uplift of the cost base to its market value) where the property is first used to produce income do not apply if at the time of the CGT event the owner is a non-resident for tax purposes.
4. The changes apply regardless of their residency status during the ownership period. There is no apportionment for periods of residency during the ownership period, rather it is based on the residency status when the CGT is triggered (i.e when the contract for sale is signed).
5. The CGT discount may apply to the gain. Where the individual has had a period of foreign residency since 8 May 2012, the CGT discount may be reduced.
6. As a foreign resident they will be taxed on the capital gain at non-resident tax rates.
7. The cost base for CGT purposes will need to be determined in calculating the capital gain.

Such costs will need to be substantiated and this would be most difficult in situations where the individual has owned the property for a long time.

To illustrate the impact of this new legislation included below is Example 1.2 which was provided in the Explanatory Memorandum to the Bill. It highlights how crucial timing of any sale is.

Example 1.2 – Main residence 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 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 the CGT event 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 in the dwelling.

Note: This outcome is not affected by

• Vicki previously using the dwelling as her main residence; and
• The absence rule in 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 the requirements were satisfied).

Are there any exceptions?

Other than the transitional provisions for CGT events that occur on or before 30 June 2020 the only limited exception where a foreign resident may be able to access the CGT main residence exemption is if the individual satisfies the “life events test”. There are two elements to this test.

To satisfy the first part of this test, the individual must have been a non-resident for a period of six years or less.

The second element of the life events test is that one of the following specified circumstances has occurred:

• Terminal medical condition of the individual, their spouse or their minor children;
• Death of the individual’s spouse or the individual’s minor children; or
• Divorce or separation of spouse (or former spouse).

In summary, an individual, who has been a non-resident for six years or less when disposing of an Australian dwelling, may still be able to access the CGT main residence exemption if one of the life events occurs.

Please note that if the property was acquired before 20 September 1985, it will still be a pre-CGT asset and therefore would not be subject to CGT upon its sale in any event.

Importance of Australian Tax residency status at the time of disposal

In conclusion, it is worthwhile recapping that for individuals having an ownership interest in a dwelling, for CGT purposes, the date of disposal of their interest in the dwelling will be the time a contract for sale is entered into. This is the relevant time to determine whether the individual is an Australian resident or foreign resident subject to the new law.

If, at the disposal time, the individual is a foreign resident, the main residence exemption will not apply and the capital gain or loss on the disposal will not be exempt for Australian tax purposes.

What to do?

Australian expatriates holding a main residence in Australia should seek advice before selling their property to understand the CGT implications. There may be planning opportunities to consider including taking advantage of the transitional period until 30 June 2020 for property they held prior to 9 May 2017.