Despite the hopes of many Australian expats and tax advisers that a degree of common sense might prevail, the Government’s 2017 Budget proposal to remove the Capital Gains Tax (CGT) main residence exemption for all foreign residents has just become a reality, with the Senate passing the Bill so that it will shortly become law. This leaves expats living overseas with just a short window until 30 June 2020 to sell their former family home and still claim the exemption, especially if they have been overseas for less than 6 years and can therefore generally make the sale completely tax-free. Anyone who bought their property after May 2017 has no such opportunity, they are already exposed to a CGT liability if they sell while they are still foreign residents.
The only helpful change from the original draft Bill is the exemption for people overseas for less than 6 years where certain life events occur, including a terminal medical condition for themselves, their spouse of child under 18, death, divorce or separation.
The most drastic part of this legislation is that foreign residents do not even get recognition for the period that they lived in the property before they moved overseas, and it is this lack of any form of apportionment that has expats and tax advisers alike so upset.
Apart from selling before 30 June 2020, the only other way to avoid the impact of these rules is to return to Australia and become an Australian tax resident again before selling, in which case the main residence will remain available at least on a pro rata basis. Be careful, however, to ensure that this involves a genuine change of tax residency – it is not enough just to come back for a few months, sell the Australian property, and then move overseas again.
The effect of the rules is shown in the case study below.
CASE STUDY – SALLY & JIM GO TO SINGAPORE
Sally is a 38 year old marketing executive with a global consulting business and lives in Sydney with her 40 year old husband Jim, a software engineer, and their three children aged 3, 5 and 8.
Sally is offered a promotion to head up the APAC marketing team in the group’s Singapore office, starting in September 2018. Jim has no problem finding a new position with a fast-growing software company based in Singapore, so they jump at the opportunity.
They plan to stay in Singapore for up to eight years, at which time their eldest daughter Michelle would be due to start year 11.
Sally and Jim bought their family home in northern Sydney for $600,000 in 2000, and in August 2018 it is valued at $2 million.
Under the existing rules, they could have used the 6 year absence rule to claim the exemption up until September 2024, with some CGT payable if they sold the house after 6 years.
However under the proposed new rules, the main residence exemption would not be available at all to non-residents. The recommendation for Sally and Jim is that they should aim at all costs to take up Australian tax residency again before selling, although they do not necessarily need to move back into the house.
Assume, for example, that the family relocates back to Australia in January 2027 but immediately decide to sell the house for $3.5 million and buy a larger one closer to the CBD for $4.5 million.
A total of 8.67 years has passed since they moved out, and under the 6 year absence rule the taxable portion of the gain is 2.67 / 8.67 = 30.8%. The total gain is the increase in value since September 2018 (when the market value was $2 million), i.e. a capital gain of $1.5 million, a taxable portion of $462,000 and total CGT of up to $217,140, but most likely less since the family will move back partway through the tax year and part of the gain would be taxed at a lower rate.
Contrast this with selling the property while still overseas, however. Not only will the 6 year exempt period be ignored, but so will be the 18 years that the family lived in the home before moving overseas. The total gain will be calculated as $3.5 million – $600,000 = $2.9 million, with tax payable at the top marginal rate of 45% being more than $1.3 million – a terrible outcome.
An even better result in terms of CGT would arise if the family moved back to Australia and into the house no later than September 2024, i.e. within the 6 year exemption period. In that case, as long as they continue living in the property, it will be treated as having always been their main residence, and on a later sale any capital gain will be entirely tax-free.
If you have any questions about how these changes may affect you, please contact your tax adviser.