The amendments provide a calculation to determine how much of the capital gain is a ‘residential capital gain’. A residential capital gain is broadly the capital gain arising from a residential dwelling over the time the dwelling was used to provide residential accommodation. The residential capital gain is calculated determining the percentage of the total ownership period of the asset on or after 1 July 2027 in which the dwelling was used for residential accommodation, with the residential capital gain being that percentage of the total capital gain. This calculation excludes periods, to the extent that it is reasonable to conclude that the main residence exemption already applied to reduce the capital gain as a result of the use of the dwelling during those periods. This reflects the fact that the gain attributable to that period is not included in the capital gain at all to the extent that the main residence exemption applies.[Schedule 1, item 6, subsection 102-6(2) of the ITAA 1997]
These capital gains relate only to gains that accrued after 1 July 2027.
Calculating residential capital gains
On 13 October 2027, Minh Anh becomes the owner of seaside land on which a large, two-level residential dwelling is constructed. She commences using the lower level as her main residence and providing the top level as residential accommodation.
On 8 May 2032, at the ending of a tenancy for the part used for residential accommodation, the dwelling is demolished. A building suitable for use as a wellness retreat is constructed and Minh Anh leases out the property to commercial tenants.
On 14 June 2035, Minh Anh ceases to be the owner of the property when it is sold. The capital gain that would be made on the sale of the property, apart from the application of the CGT main residence exemption and after taking into account cost base indexation, would be $3.9 million.
Minh Anh applies the Subdivision 118-B main residence exemptions to reduce the amount of that capital gain, taking into account:
the number of non-main residence days in the ownership period (1132 of 2792); and
the reasonable extent to which the original dwelling was used for an income producing purpose (40 per cent).
On the application of those exemptions, Minh Anh reduces the capital gain of $3.9 million by $1,391,260.
The amount of capital gain to be included in determining if Minh Anh has a net capital gain for the 2034/35 income year is $2,508,740.
None of this gain is a deferred residential capital gain or a deferred non-residential capital gain. The amount of the gain that is a residential capital gain is equal to the amount of the capital gain multiplied by a fraction, being the number of residential accommodation days divided by the total number of days in the post-1 July 2027 ownership period. The remainder of the gain will be a non-residential capital gain.
The residential accommodation days includes the fractional part of those days in which the dwelling was used for providing residential accommodation, with the fraction determined based on the extent of use. Based on the apportionment made for the main residence exemption this is a 4/10th fraction of 1660 days = 664.
Days in the post-2027 ownership period is 2792, reduced by the parts of days for which it is reasonable to expect a capital gain has been disregarded by the operation of the main residence exemption. In Minh Anh’s circumstances, it is reasonable to ascertain on the basis of the attribution made under the exemption that this will be a 6/10th fraction of each of the 1660 days. Given this, the days in the post-2027 ownership period are 1796 (2792 less 996).
As a result, Minh Anh has:
a residential capital gain of $927,507 ($2,508,740 x 664/1796)
a non-residential capital gain of $1,581,233.
Non-residential capital gains
‘Non-residential capital gains’:
excludes gains arising under Subdivision 112-E where there is a deferred gain arising from the deemed sale of a CGT asset on 30 June 2027; and
includes any gains that do not fall within the meaning of ‘residential capital gains’ (set out above).[Schedule 1, item 6, subsection 102-6(1) of the ITAA 1997]
This covers capital gains arising from asset classes including commercial property, company shares or interests in a trust, provided the gains arise from assets held on or after 1 July 2027.
Deferred residential capital gains
‘Deferred residential capital gains’ include:
gains arising from CGT assets covered by Subdivision 112‑E where there is a deferred gain arising from the deemed sale of the asset on 30 June 2027; and
gains arising from the CGT event happening to a CGT asset that is a residential dwelling to the extent it was used or held for residential accommodation.
The amendments provide a calculation to determine how much of the capital gain is a ‘deferred residential capital gain’. A deferred residential capital gain is broadly the capital gain arising from a residential dwelling over the time the dwelling was used to provide residential accommodation before 1 July 2027. The residential capital gain is calculated by determining the percentage of the total ownership period of the asset before 1 July 2027 in which the dwelling was used for residential accommodation, with the deferred residential capital gain being that percentage of the total capital gain. A period that ends on a day includes that day (see subsection 36(1) of the Acts Interpretation Act 1901). As discussed above, this calculation excludes periods to the extent that it is reasonable to conclude that the main residence exemption already applied to reduce the capital gain as a result of the use of the dwelling during those periods.[Schedule 1, item 6, subsection 102-6(4) of the ITAA 1997]
This category of capital gains arises because there has been a realisation event relating to the CGT asset for which an initial notional gain was disregarded (see the discussion of Division 112 below). Due to the realisation event, the deferred gains are crystallised and the individual or individual beneficiary is treated as having made a gain equal to the deferred gain in the income year in which the realisation event occurs.[Schedule 1, item 6, subsection 102-6(5) of the ITAA 1997]
Deferred non-residential capital gains
‘Deferred non-residential capital gains’:
includes gains arising from CGT assets covered by Subdivision 112-E where there is a deferred gain arising from the deemed sale of the asset on 30 June 2027; and
excludes so much of the gains that fall within the meaning of ‘deferred residential capital gains’ (set out above). [Schedule 1, item 6, subsection 102-6(3) of the ITAA 1997]
This covers capital gains arising from asset classes including commercial property, company shares or interests in a trust where the gains are arising from assets that was deemed to have been sold on 30 June 2027 and reacquired on 1 July 2027.
This category of capital gains arises because there has been a realisation event relating to the CGT asset for which the initial notional gain was disregarded under the new Subdivision 112-E (see the discussion of Division 112 below). Due to the realisation event, the deferred gains are crystallised and the individual or individual beneficiary is treated as having made the deferred gains.[Schedule 1, item 6, subsection 102-6(5) of the ITAA 1997]
Capital losses
Once an entity has identified the different categories of capital gains, an entity can apply its current year capital losses against each category in the following order:
deferred non-residential capital gains;
deferred residential capital gains;
non-residential capital gains; and then
residential capital gains.
This means you first reduce any deferred non-residential capital gains in an income year by any capital losses in that income year. Then, if any losses remain after the gains in the category have been reduced to nil, you reduce any deferred residential capital gains by any capital losses that remain after you have reduced gains in the previous category.
This process allows for capital losses to be utilised against older capital gains first and also distinguishes them between residential and non-residential gains to cater for step 3 (about quarantined amounts).
Deferred capital losses
A capital loss in an income year can include losses arising from CGT assets covered by Subdivision 112-E where there is a deferred loss arising from the deemed sale of the asset on 30 June 2027 that has been crystallised.
In an income year where there is a realisation event happening in relation to the CGT asset, the entity is treated as having made a capital loss equal to the amount of initial notional loss (which was previously disregarded). These capital losses can be used to reduce capital gains made in the income year or carried forward to later income years.
Step 2 - Apply any carried forward net capital losses against any remaining capital gains in the same order as they appear in Step 1.
Under step 2, an entity applies any unapplied net capital losses from earlier income years to further reduce any remaining amounts after step 1 within each category of capital gains. The same order applies as in step 1, so you start with further reductions to any deferred non-residential capital gains and proceed through the categories in order.
Step 3 - Apply any current year quarantined amount against any deferred residential capital gains that are remaining.
The term ‘quarantined amount’ is discussed in Chapter 2 of this Explanatory Memorandum dealing with amendments relating to negative gearing. Broadly, this refers to any amount by which a taxpayer’s other deductible expenditure incurred in using or holding residential dwelling for residential accommodation exceeds their assessable income from using or holding residential dwellings in an income year.[Schedule 1, item 6, subsection 102-5(1) of the ITAA 1997]
A quarantined amount can be applied against any deferred residential capital gains remaining amount after step 2. This enables entities with un-deducted amounts arising from expenditure relating to residential dwellings used as residential accommodation to use these amounts to reduce their residential capital gains amounts, including from the disposal of new residential dwellings or affordable housing.
Step 4 - Apply any remaining quarantined amount against residential capital gains that are remaining.
Similar to step 3, a quarantined amount can be applied against any residential capital gains remaining amount after step 3.
Step 5 - Reduce the amount by any discount percentage that can apply
Reduce by the discount percentage (calculated under Division 115) each amount of a discount capital gain remaining after step 4 (if any).
Note that only some entities and CGT assets are eligible for discount capital gains under these amendments.
Step 6 - Apply any small business CGT concessions
If any remaining capital gains after step 5 are eligible for a small business concession under Subdivisions 152-C to 152-E, apply those concessions to each of the capital gains as provided by the Subdivisions.
Step 7 - Add up any remaining capital gains: this is the net capital gain
Add up the amounts of any remaining capital gains in each category, the sum of those amounts is an entity’s net capital gain for the income year.
How to calculate your net capital gain
Asher is an Australian resident who conducts a range of investment activities including in property used to provide residential accommodation. Asher sells the following investments in the 2030/31 income year:
Rights, purchased in May 2002, for a sale price of $1.2 million;
Property A, purchased in January 2008 and used from that time to provide residential accommodation, for a sale price of $3.2 million
Property B, purchased in April 2029 and used to provide residential accommodation, for a sale price of $1.4 million; and
ASX shares purchased in August 2030 and sold in November of that year for $50,000.
Asher has, for that income year, a carried forward capital loss of $200,000 and a quarantined amount from the conduct of a portfolio of residential property investments of $1.4 million. The capital gains will not meet the conditions for the small business concessions in Division 152.
Asher calculates the following capital gains:
Rights: a deferred non-residential capital gain of $600,000 and a non-residential capital gain of $400,000.
Property A: a deferred residential capital gain of $1 million and a residential capital gain of $500,000.
Property B: a residential capital gain of $280,000.
ASX shares: a non-residential capital gain of $12,000.
Asher applies the section 102-5 method statement as follows:
Step 1: Asher has:
Deferred non-residential capital gain of $600,000;
Deferred residential capital gain of $1 million;
Non-residential capital gain of $12,000;
Residential capital gain of $780,000; and
As Asher has no current year capital losses, no reduction is made to these amounts at Step 1.
Step 2: The deferred non-residential capital gains amount of $600,000 is reduced by the carried forward capital loss ($200,000) to $400,000.
Step 3: The deferred residential capital gains amount of $1 million is reduced by the quarantined amount ($1.2 million) to nil.
Step 4: The residential capital gains amount of $780,000 is reduced by the remaining quarantined amount ($200,000) to $580,000.
Step 5: The deferred non-residential capital gain that Asher made on the sale of the rights relates to a pre-1 July 2027 gain and is therefore a discount capital gain. The discount percentage (50 per cent) is applied to reduce the remaining $400,000 of this capital gain to $200,000.
Step 6 does not apply, as the conditions for the small business concessions are not met.
Step 7: Asher has a net capital gain of $792,000 for the 2030-31 income year, made up of $200,000 (deferred non-residential capital gain) plus $12,000 (non-residential capital gain) plus $580,000 (residential capital gain). This amount is included in assessable income.
Consequential amendments are made to the guidance provisions outlining how to work out a net capital gain or loss, to reflect the new method statement in section 102-5. Key changes explain that certain gains are reduced in a particular order, and to apply any quarantined amount when adjusting relevant residential capital gains.[Schedule 1, item 3, section 100-50 of the ITAA 1997]
Division 112. Modifications to the cost base
The new CGT regime distinguishes capital gains that accrue before and after 1 July 2027.
The Bill amends Division 112 of the ITAA 1997 (Modifications to the cost base) to deal with situations where a CGT asset was acquired before 1 July 2027 and a CGT event happens to it after that date. It does so by deeming the CGT asset to be disposed of just before 1 July 2027 and reacquired on 1 July 2027. Any gain or loss from the deemed sale is deferred. Then, once there is a later realisation event in relation to the CGT asset, the taxpayer is treated as making a capital gain or loss equal to the amount of any initial notional gain or loss, in addition to any capital gain or loss from the realisation event. This means that the total amount included in the taxpayer’s capital gains for the income year in which the asset is disposed of effectively has two components. It is possible that one or both of these components may be nil.
The first component is equal to the initial deferred gain or loss - the gain or loss accrued between when the asset was acquired on 1 July 2027. This gain is calculated under the law as it applied prior to the amendments made by this Bill in respect of the deemed sale, and will be a discount capital gain if the initial notional gain was a discount gain. The capital proceeds for the sale are generally taken to have been equal to the market value of the asset as at 1 July 2027. However, the taxpayer may instead choose to calculate the value using an apportioning method determined by the Minister by legislative instrument. [Schedule 1, item 13, sections 112-155, 112-160, 112-165 and 112-170 of the ITAA 1997]
The rules applying to the first component (the notional gain just before 1 July 2027) deem CGT events and capital gains or losses to have occurred. They are modelled on sections 294-115 and 294-120 of the ITTP Act, for consistency of approach.
The second component is the gain accrued between 1 July 2027 and the time of the CGT event that occurred when the asset was realised, which is calculated under the law as amended by the Bill.
Both amounts are included in the taxpayer’s assessable income in the income year in which the CGT event occurs.
In summary, for an Australian resident individual or trust:
A CGT asset held before 1 July 2027 is deemed to be sold just before 1 July 2027 and reacquired on 1 July 2027, to ascertain its market value (or equivalent) at that time (sections 112-155 and 112-165).
If the deemed sale results in an initial deferred gain or loss (calculated under the old law) - this gain or loss is disregarded. Recognition of this gain or loss is deferred until a CGT event happens to the CGT asset (a realisation event within the meaning of section 977-5) (sections 112-160 and 112-170).
In the income year in which a realisation event occurs in relation to the CGT asset, both an amount equal to the initial deferred gain or loss up until 1 July 2027 and the capital gain (or loss) arising from that date until the realisation event are included in calculating any net capital gain for that year under Division 102 (and, in the case of a trust, Subdivision 115-C).
Similar arrangements are made for pre-CGT assets under sections 112‑175 and 112‑180 - these are discussed in more detail separately, below.