Nick Bruining Q+A: Inheritance windfall can help set you and your fiance up for life

Question

I am in my mid 30s and recently received a sizeable inheritance from my grandmother of $350,000, which I have placed into my mortgage offset account.

The mortgage is against the unit I live in. My plan is to buy an investment property jointly with my fiance that would be big enough for us when we start a family, which might be in the next five years.

I am interested in understanding how capital gains tax would apply after we move into the new property and eventually sell that. Will I need to pay any tax or will that be exempt?

Answer

There are a couple of issues to be aware of and it is fortunate that you contacted us before the purchase of the new property.

The mortgage offset account is a separate arrangement from the mortgage, and while it is reducing the interest cost of the loan to you it is not a reduction in the loan.

If you simply use this money to purchase the new property and withdraw the money from the offset account, the increased interest payable is not tax deductible for negative gearing purposes. To achieve this, you will need to actually pay down the loan and then redraw the loan for the purpose of buying the investment property.

When you eventually sell the unit, it is likely to be fully exempt from CGT as it was your primary dwelling and not used to conduct a business. That is referred to as your “main residence exemption”.

On the assumption that you will not occupy the new property when it is first purchased, a variation on the MRE will apply. In this case, the period where it is used as a rental property is subject to CGT.

For example, let us assume the purchase price all-up of the new home is $1 million. It is available for rent for nearly three years, which works out to be exactly 1000 days. Ten years later — or 5000 days since the purchase date — you sell the property for $2m. Your gross profit on the sale is $1m.

This amount would be multiplied by the proportion of time it was available for rent, so 1000 days of the 5000 works out to be 20 per cent, which is $200,000 of the gross sale profit.

Because the asset was held for more than 12 months, the 50 per cent discount rate applies and that means that $100,000 will be divided between you both and added to your incomes in the financial year you sell the house.

The remaining portion of the profit — or $800,000 — will attract the MRE and no tax will be payable.

Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association