Only a partial exemption from capital gains tax (CGT) is available to the extent a main residence is used for an income-producing use: section 118-190 of the Income Tax Assessment Act (ITAA) 1997.
As the CGT main residence exemption is, or can be, so valuable – there is often no bigger tax break to an individual in their lifetime; an individual working in their business or their employment from a home they own will be looking to preserve the full CGT main residence exemption (MRE) where they can.
Setting the scene
For most taxpayers opportunity to claim the full CGT MRE will be straight forward. The Australian Taxation Office (ATO) website
Home-based business and CGT implications | Australian Taxation Office https://cutt.ly/ZDOjOWt
re-assures a home owner simply working from home from a desk, chair and a computer that a full CGT MRE will be available where the ATO states:
Generally, when you sell your home CGT doesn’t apply. However, if you used any part of your home for business purposes, you may have to pay CGT. CGT won’t apply if any of the following occurred with your home-based business:
– You operated your business from a rented home.
– You didn’t have an area specifically set aside for your business activities.
– You operated your business through a company or trust.
You only have to pay CGT for periods when you used your home for your business.Home-based business and CGT implications | Australian Taxation Office https://cutt.ly/ZDOjOWt
But the ATO’s page isn’t the whole story. The ATO’s first dot point is so obvious that it shouldn’t be in the list but is helpful to any renters that may happen on to this page of course. The ATO’s second dot point is reassuring especially as all that is physically needed by many workers working from home is that chair, desk and computer. This derives from the distinction between homes with a place of business and those not with a place of business and how they are treated for the CGT MRE considered later in this blog. The third dot point is partly right. What about, though, where a related company or trust, which is a separate entity to an individual owning his or her home:
- pays rent to the owner for the use of the home?; or
- meets or helps meet the expenses of the owner of the home?
Separate entity – related company or trust
Let’s say Fred owns his own home and Fred has a related company from which Fred conducts his business from home. If the company rents a room in the home then the CGT MRE is reduced to a partial CGT exemption when Fred sells his home as:
- Fred has earned rental income from the company, a separate legal entity; and
- Fred will either have deducted, or could have deducted, interest on money borrowed put to the home, if any – see paragraph 118-190(1)(c) and sub-section 118-190(2);
as section 118-190 then applies.
Don’t charge rent
If Fred is the sole owner of his company then an obvious first measure of tax planning to ensure Fred keeps the full CGT MRE is for Fred not to charge rent to the company.
But where Fred charges no rent to the company this has implications for expenses like heating and cooling and other expenses Fred incurs, and has no rent to cover, when the company occupies his home for no charge and carries on its business from there remembering:
- Fred is not entitled to deduction for the expenses of his company which is a separate entity to him and which are essentially private to him; and
- the company is not entitled to a deduction for expenses for which Fred, rather than the company, is responsible even where the company pays those expenses (without considering fringe benefits tax implications where Fred is also an employee of the company as well as a shareholder).
Can the company instead reimburse Fred, sustain deductions for the expenses of the home it meets as business expenses and not disturb the CGT MRE position of Fred?
Legalities – a licence!
Firstly the company is, as stated, a separate legal entity to Fred. To clarify its basis for using Fred’s home, the company and Fred should document what the company can do at his home.
Secondly a document between Fred and the company under which the company can enter and use Fred’s home to run its business without paying rent to Fred is likely not a lease. It is a licence to enter the home granted by Fred and to do the things at the home which Fred allows the company to do under the licence.
Thirdly the licence terms can specify and delimit the home expenses of Fred which the company will reimburse to Fred.
Running expenses vs. occupancy expenses
The Commissioner of Taxation’s Taxation Ruling TR 93/30 Income tax: deductions for home office expenses explains two significant dichotomies:
Firstly TR 93/30 distinguishes between running expenses, being the costs of living at a home, and occupancy expenses which are the costs of owning a home. These examples are given:
Occupancy expenses – relating to ownership or use of a home which are not affected by the taxpayer’s income earning activities (i.e., occupancy expenses). These include rent, mortgage interest, municipal and water rates, land taxes and house insurance premiums.
Running expenses – relating to the use of facilities within the home. These include electricity charges for heating/cooling, lighting, cleaning costs, depreciation, leasing charges and the cost of repairs on items of furniture and furnishings in the office.Paragraph 6 of TR 93/30
Secondly, from the tax cases on the issue, TR 93/30 draws a distinction between an area of a home to be treated as a place of business and an area of a home which is not to be so treated. This ties back to the ATO observation in the second dot point on Home-based business and CGT implications about a part of a home specifically set aside for business activities.
Safe harbour for a full CGT MRE
To my mind a CGT MRE safe harbour for Fred would be for the licence:
- to allow Fred reimbursement by the company for running expenses related to the use of the home by the company for business purposes; and
- to preclude reimbursement by the company for occupancy expenses;
to Fred. Then the ATO would have no reason to treat payments by the company to Fred or payments by the company to meet expenses of the home on Fred’s behalf as either rent or as contributions to Fred’s occupancy expenses so that the CGT MRE of Fred then diminishes to a partial exemption where these payments do not exceed the applicable running expenses that Fred can recover under the licence.
On the other hand a reimbursement of occupancy expenses to Fred is an indicator to the ATO that Fred is allowing a physical part of the home itself, whether or not that part is a place of business or not based on the indicators of a place of business described in TR 93/30 (see below), to be used by the company in its business to earn income and a notional apportionment between use as a main residence and income earning leading to a diminished partial CGT MRE under section 118-195 might then follow.
Sole trader or partnership
Where the owner of the home is a sole trader, or where the owners of the home are carrying on a business in partnership, then the issue of licence to enter and use the home and reimbursement of home expenses to owners as separate entities won’t arise.
In those cases closely abiding by TR 93/30 can give home owners working from home safe harbour from a partial CGT MRE so long as:
1. the home has no place of business viz like:
the area is clearly identifiable as a place of business;
the area is not readily suitable or adaptable for use for private or domestic purposes in association with the home generally;
the area is used exclusively or almost exclusively for carrying on a business; or
the area is used regularly for visits of clients or customers.from paragraph 5 of TR 93/30. A home-based doctor’s surgery is given as an example of a place of business in paragraph 4 of TR 93/30.
2. tax deduction claims by the sole trader or partnership are constrained to running expenses and occupancy expenses are excluded from those tax deduction claims.