In this blog we look at the fallout from COVID in terms of the impact the pandemic has had on the tax treatment of the family home – and the consequences that may flow for relationship breakdown and asset division. This blog was co-written by Phil Diviny, Partner at Madgwicks Lawyers.
Implications of the COVID-19 pandemic on Capital Gains Tax
The COVID-19 pandemic provided an opportunity to rethink the way people (from a broad spectrum of industries and professions) worked.
In Australia, a survey conducted in 2020 found that 67% of employed respondents sometimes or always worked from home compared to 42% pre-COVID. This change of behaviours and working practices inevitably has financial consequences – not in the least tax ones.
Working from home may open up the ability to claim certain home-related expenses as tax deductions against employment income or business income. However, this is a double-edged sword, as making any claims for deductions may trigger additional tax implications upon the sale of a main residence.
Tax deductions for working from home
In order to claim tax deductions for working from home expenses, a person must be able to satisfy that they were working from home to fulfil their employment duties, and that they incurred additional running expenses as a result of working from home. According to the Australian Taxation Office (ATO), running expenses are those expenses which relate to the use of facilities in your home for work purposes, and include:
- Electricity expenses for heating, cooling and lighting
- The decline in value of office furniture/devices (e.g., computers)
- Internet expenses
- Phone expenses
- Cleaning expenses
Throughout the COVID-19 pandemic, the ATO allowed individuals to use an all-inclusive “shortcut” rate of 80 cents per hour as the basis for a claim for the additional running expenses incurred by working from home. The shortcut method ceased to be available on 30 June 2022.
The ATO also stated that people can only claim occupancy expenses as deductions in limited circumstances. Occupancy expenses include things such as interest on residential loans, rent, building insurance and land taxes. Generally, occupancy expenses are only deductible where your home is a ‘place of business’ and deductions will not be available if you are merely an employee working from home where you are usually office-based.
Indicators that an area of your home that you’ve set aside is a ‘place of business’ include:
- Your home is your principal place of work (i.e., no other location is provided to you by your employer/you run a business from home)
- The area of your home is not easily suitable or adaptable for private or domestic use
- The area of your home is used exclusively or almost exclusively for your business
- The place of business is clearly identifiable (e.g., signage identifying your business at the front of your home)
- Your home is used regularly for business visits by your clients
Taxpayers should be wary that claiming occupancy expenses may impact the applicability of the main residence exemption upon the sale of their property.
Capital gains tax implications
Capital gains tax (CGT) is the tax you pay on the gains you derive from selling assets. Most taxpayers are exempt from paying CGT upon the sale of their main residence. Making claims for additional running expenses incurred whilst working from home is unlikely to affect an employee’s liability for CGT upon the sale of a property.
Notably, where an individual is operating a business from their home, this may result in a portion of their home becoming subject to CGT upon sale. This is because the home is no longer exclusively being used as a main residence as it is partially used for income-producing purposes. The amount of CGT which an individual would be liable for is dependent on the amount of time the proportion of the property was used for income-producing purposes. The ATO provides useful information for determining the assessable part of your capital gain.
Importantly, homeowners should be aware that not claiming deductions for occupancy expenses even when they are entitled to them may leave them worse off, since the ATO will still likely apply CGT robustly and withdraw part of the capital gains exemption.
CGT and family law – main residence exemption
One key thing to think about in family law asset division is tax planning.
For example, if a husband and wife live in a property – not claiming any deductions for home as a place of business. However, during COVID-19, the husband set up a business and ran that business entirely from home. The wife works wholly outside the home. For the period before COVID, the sale of the home would likely have attracted main residence exemption and no CGT would have been payable and the parties go on their way. After COVID, the sale of the home may attract a CGT liability. In this example, it would possibly be disadvantageous to the wife as she did not ‘taint’ the main residence exemption. This tax risk may need to be considered as part of the bigger picture.
CGT and family law – rollover relief
Traditionally in family law, when two people separate, the assets which attract CGT are sometimes transferred from one of the couple to the other. This transfer will usually qualify for relationship breakdown rollover relief. This means that the CGT which normally applies when ownership of an asset changes is deferred. Rollovers are typically made as a result of a court or consent order under the Family Law Act 1975 (Cth).
Where a rollover applies, the transferor may disregard the capital gain on the property where their interest is provided to the transferee and they inherit the transferor’s cost base in the property. The liability for CGT is therefore transferred to the transferee upon the sale of the asset. It is worth noting that where the transferee already has a legal interest in the property, they must calculate their capital gain separately from that of the interest transferred to them by their former spouse.
Following these rules, it is likely that any CGT attracted as a consequence of occupancy expenses claimed on the main residence throughout the duration of the marriage will be the liability of the spouse who inherits the entire interest in the property following separation.
So for example, assume a husband and wife separate. They acquired an investment property in the name of the wife during the marriage. As a result of the divorce, the investment property may be transferred into the husband’s name. the CGT rules will normally apply to the effect that:
- The wife will not pay CGT on the transfer of the property to the husband (providing the conditions for rollover relief are met)
- The husband inherits the tax history of the property
- When or if the husband sells the property, he will have a CGT liability reflecting any gain made on the property during the whole of his and his former wife’s ownership.
As working from home becomes more regular across the workforce, it is important for individuals to understand how their working arrangements may affect their tax liabilities and even the way property is divided or liability is allocated between a couple on divorce.
It is always critical to get tax advice before reaching and agreeing any property settlement on the breakdown of the relationship.
Different assets (and the way they are held / owned) attract different tax treatment – for example, relationship, breakdown rollover relief is possible for a transfer from a family trust to a spouse but not the other way around. Similarly, there are tax considerations beyond CGT including, stamp duty and possibly international tax issues that also need to be considered.
DISCLAIMER: This blog does not constitute formal legal advice and we always recommend that both parties to an asset separation agreement or proceedings seek independent tax advice.