A change in Capital Gains Tax (CGT) exemption rules could see tens of thousands of expats stuck between a rock or a hard place thanks to COVID-19 delivering a double whammy of restrictions on viewings and financial uncertainty.
A change in law which passed 12 December 2019 means Aussie homeowners living overseas have until the end of the financial year to sell their property to avoid copping a potentially massive capital gains tax slug.
The Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures) Bill 2019, Section 118-110 ITAA9, sets out the basic rules for a dwelling to qualify for the main residence exemption when a CGT event happens, says David Montani, a Chartered Accountant and the National Tax Director at Nexia Australia.
“A core amendment that the Act makes is the addition of s 118-110(3), (4) and (5), which disallows the exemption for foreign residents.”
Prior to the law abolishing the main residence exemption for foreign residents being adopted, expats, or foreign resident for tax purposes, could sell their main residence without incurring CGT provided it had not been rented for more than six years consecutively.
The changes have been in the air for some time; Montani explaining they formed part of a raft of measures announced to reduce pressure on housing affordability in the 2017-18 Budget.
It was only by chance that London-based expats Greg Pritchard and My Truong happened upon a random accountancy website alerting them to looming changes to the Australian capital gains tax regime.— The Sydney Morning Herald (@smh) February 15, 2020
However, he says the original Bill was released before last year’s election to almost universal condemnation from the tax profession and it was believed the Bill might not be progressed any further.
So when it received royal assent on 12 December 2019 (the Act), it has left many expats with very little notice to either sell up soon or face a CGT bill.
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The fine print
As the law is being applied retrospectively, property owned prior to 7:30pm (AEST) on 9 May 2017 will only qualify for the CGT main residence exemption if disposed of (the time you entered into the contract, or where you do not sell under a contract, the time of settlement)
- by 30 June 2020 provided you meet the other requirements for the exemption
- after 1 July 2020 only if you satisfy the life events test.
For a main residence acquired at or after 7:30pm (AEST) 9 May 2017, the CGT main residence exemption only applies if you satisfy the life events test.
And what is the life events test? The law stipulates you must, at the time of the disposal of your residential property in Australia:
- be a foreign resident for tax purposes for a continuous period of six years or less and, during that time, one of the following must have occurred:
- you, your spouse, or your child under 18, had a terminal medical condition
- your spouse, or your child under 18, died
- the CGT event involved the distribution of assets between you and your spouse as a result of your divorce, separation or similar maintenance agreements.
“In short, foreign residents of more than six years’ continuous duration are denied the main residence exemption, no exceptions. The fact that a dwelling may have been their main residence for many years beforehand is irrelevant,” Montani says.
This applies to properties purchased since CGT was introduced on 20 September 1985, so for those that have owned a property through booms, the CGT could be substantial.
“A few months could cost hundreds of thousands of dollars”
Montani shares this example case of how delaying a sale could cost expats hundreds of thousands of dollars:
“Josh purchased his home on 1 October 1985 for $70,000. He moved overseas on 1 October 2019, and became a foreign resident. He intends to choose to apply the absence rule in s 118-145 ITAA97 such that his house will continue to be treated as his main residence.
Josh executes a contract to sell his house on 1 October 2020 for $970,000, with a capital gain of $900,000 arising. Having been a foreign resident for only a year, Josh is not an “excluded foreign resident”, but let’s say he does not satisfy the life events test. Accordingly, s 118-110(3)(b) ITAA97 applies, as Josh is a foreign resident of six years or less, and does not satisfy the life events test as at 1 October 2020. Therefore, the main residence exemption is not available (to any extent) in respect on his $900,000 capital gain.
The property having been Josh’s home for 34 of the 35 years he owned it is irrelevant. The fact that Josh intended to apply the absence rule is also irrelevant.
Assuming the capital gain is the only relevant matter for Josh’s 2020-21 Australian income tax return, his tax liability is calculated as follows:
“If Josh had executed the sale contract a few months earlier, by 30 June 2020, the transitional rule would operate, meaning none of these amendments would apply. The main residence exemption, including his choice to apply the absence rule, would have been available, resulting in his $900,000 capital gain being fully disregarded. The short delay has cost him almost $190,000.”
COVID-19 has seen a tight sales deadline become even more challenging
While just over six months may be a tight deadline to make the decision to sell or hold onto a property before the change comes into effect (assuming the property was purchased before the May 2017 cut off) COVID-19 has added further pain to the equation.
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The prohibition of open house inspections announced by the federal government has made conducting sales far harder. While open house inspection restrictions have been eased to ten people at a time as of Monday April 27 in Western Australia, a move likely to be replicated across Australia as states and territories begin to see lower transmission rates, it doesn’t leave a lot of wriggle room.
Then there is the impact global financial insecurity has on the pool of potential buyers alongside the heavy hit take by the rental market reducing potential investment property buyers from the ring.
While the impact of COVID-19 is steadying in Australia, a recently released report indicates industry professionals largely agree that the effects of COVID-19 on Australia’s property market will be felt within the next three to 12 months. While many noted prices could be higher than they are at present by this time next year, this is cold comfort to those stuck paying the CGT should they wait for the market’s recovery.
“There’s no doubt that we’ve seen a significant drop in clearance rates throughout April. Families and homeowners have a lot of other concerns and considerations on their mind right now, so delaying a major purchase by a few weeks is understandable,” says Alex Lumsden, founder of digital real-estate marketing agency, Lumsden Agency.
The Tax-expert take out message
From a tax perspective, Montani says anyone who settled the purchase of their home before 7.30 pm (AEST) on 9 May 2017 and has since become a foreign resident, has a significant decision to make – and they need to make it very soon. The three options?
- Sell your home by 30 June 2020 – under the transitional rule, none of these amendments apply, and a full or partial main residence exemption will be available as if the amendments were never enacted.
- Keep the home, understanding the main residence exemption will no longer be available from 1 July 2020. If you are still a foreign resident when the home is sold, any capital gain or loss will not be disregarded (the exception is a foreign resident of six years or less who satisfies the life events test.)
- Return to Australia (whenever in the future) and become an Australian resident again. Then sell their home while they are an Australian resident, meaning the amendments do not apply.
“The issue has been that if you wanted to sell by 30 June, but couldn’t, your former home’s tax-free status is lost entirely. That’s a very harsh outcome. But now, COVID-19 has made things far more difficult. Right now, seven weeks away, it’s almost impossible,” Montani says.
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Words by Melanie Hearse
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