Q&A: Right to reside under a formal family agreement

Article from The Taxpayer. Published February 2019.

A scenario raised by a Tax & Super Australia member relates to the Capital Gains Tax (CGT) implications of a lifetime right to reside in a property, not under a will, but under a formal agreement between two family members. Our Tax Team shows how TR 2006/14 can help provide guidance in this situation.

Scenario

A mother is looking to sell her home. Her son is also selling his home and they plan to purchase a new home with the proceeds. The mother will make a contribution to the cost of the new property but will not go on the title. It is estimated that her contribution will be about 25% of the total cost of the property. A formal agreement between the mother and the son will be entered into for the mother to have a lifetime right to reside in the property.

Question

  1. Will the above scenario give rise to CGT event D1 in section 104-35 of the ITAA 1997 and thus result in the son realising a CGT event?
  2. If the answer to question 1 is “yes”, can the son include his contribution to the purchase of the new property as part of the cost base to be included in the creation of the lifetime right to reside which is the CGT event?
  3. Is there a way to structure the above situation without a capital gain being realised?

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Guidance

Does CGT event D1 apply for the son in this case?


First off, what is CGT event D1? This relates to creating contractual or other rights. The creating of the right is the CGT event and it includes a right to reside in a property for life (or a term of years) granted other than pursuant to a mere family or social arrangement.


Para 105 of TR 2006/14 indicates that a right to reside in a property for life (or a term of years) is not equivalent to a legal or equitable life interest. The right is a mere personal right which can’t be assigned. CGT event D1 in section 104-35 happens when such a right is granted. 


Some relevant paragraphs later in TR 2006/14 provide guidance on the definition of a grant of a lifetime right to reside in a property. These include:

  • Para 195: Whether a life estate or right to occupy is created depends on all the facts and circumstances of a particular case. Generally, if a taxpayer is granted a right to “use and occupy” a property (that is, they have the rights to rent and profits) this indicates that a life estate is created. However, if a taxpayer is merely permitted to reside in a particular property then this would more likely be treated as the grant of a right to occupy the property.
  • Para 196: A lifetime right to reside in a property can be granted in a family situation where, for example, a parent sells their main residence and pays a lump sum to a child for the right to reside in the child’s dwelling and to have the child provide domestic assistance, such as washing, cooking and cleaning. This is more than a mere family or social arrangement. The arrangement is usually formal and documented in writing to provide evidence of the creation of the right to reside which may be needed if the family’s circumstances change. Accordingly, CGT event D1 happens when these rights are created. Whether an arrangement creates these rights will depend on the particular facts and circumstances of the case and the intention of the parties.


CGT event D1 happens when such a right is granted. Once it is determined that a CGT event (D1) occurs, the next step is to consider the position of the grantor of the right (the son in our scenario).


Para 107 of the ruling indicates that the capital proceeds the grantor receives from the CGT event include the amount of money and the market value of any property received, or entitled to receive, in respect of the event happening. Para 108 goes on to say that if the grantor received no capital proceeds from CGT event D1 the grantor is not taken to have received capital proceeds equal to the market value of the created rights. Para 109 explains: “However, if there are some capital proceeds, and the grantor and the party in whom the right has been created do not deal with each other at arms length, the grantor will be taken to have received the market value of the right, rather than the money or property actually received if these amounts are different”. (In our scenario the mother was to contribute in the vicinity of 25% of the total cost of the property.)

What is the market value of a lifetime right to reside in a dwelling?

Para 110 says it will depend on a number of factors, including the life expectancy of the person who is the subject of the right and the nature and location of the dwelling. It will be relevant to have regard to what a willing but not anxious buyer would be prepared to pay for such a right even if there were no actual market for it.


Regarding the question of whether the son can include his contribution to the purchase of the new property as part of the cost base to be included in the creation of the lifetime right to reside which is the CGT event, para 106 states:


“The grantor of the right makes a capital gain if the capital proceeds from creating the right are more than the incidental costs incurred that relate to the event. They make a capital loss if the capital proceeds are less than the incidental costs: subsection 104-35(3).”


Para 112 then goes on to say that no part of the acquisition cost of the property in respect of which the right of occupancy is granted (or other costs relating to that property) can be treated as incidental costs. (This is not good news for the son in our scenario.)

What about main residence exemption?

Para 113 indicates that any capital gain or loss the grantor might make from granting a right to occupy a dwelling which, at the time of the grant, was their main residence, cannot be disregarded under subdivision 118-B. Subsection 118-110(2) lists the CGT events relevant for the purposes of the main residence exemption – CGT event D1 is not included in that list.

 

Position of grantee (mother)

Para 114 notes that the person who is granted a right of occupancy (the grantee) acquires the right when the contract granting the right is entered into or the right created.


The cost base of the right is covered at para 115 which indicates that the acquisition cost of the right is the amount of money paid and the market value of any property given, or required to be paid or given in respect of its acquisition. Para 116 goes on to say if the grantee did not incur any expenditure to acquire the right, they are not taken to have acquired the right for its market value. Further, para 117 details that if the expenditure incurred by the grantee to acquire the right was more or less than its market value, the grantee will be taken to have incurred market value expenditure if they did not deal with the grantor at arm’s length in relation to the granting of the right.


For the position of the grantee (mother), it is also worth noting that at para 119, it details that a licence or right to occupy a dwelling constitutes an ownership interest in a dwelling for the purposes of the main residence exemption.


Regarding the question of when would a capital gain not be realised in similar situations, as previously mentioned, a mere informal family arrangement where relatives may reside at each other’s dwellings with no intention to create legal relations will not result in CGT event D1 happening.


For further information on the topic, TD 2018/15 can be referred to in relation to CGT event D1, indicating that:

  • any capital gain or capital loss from the grant cannot be disregarded merely because the asset was acquired prior to 20 September 1985, and
  • any capital gain from the grant is not a discount capital gain.


Para 16 of the determination details that the rights contemplated by CGT event D1 include a licence. An example of a licence is the authority to occupy land. A licence is distinguished from a lease by the fact that a licence does not confer the right of exclusive possession of land.


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