Why accessing the small business CGT concessions for home-based business properties is becoming problematic

Can a home-based business owner qualify for the small business CGT concessions on the sale of their property?

I have seen this issue arise more frequently in practice, including a private ruling application that confirmed eligibility for the small business CGT concessions on the sale of the property. The reason for the increased interest is simple:

• It’s a grey area of the tax law; and
• The ATO has recently signalled a more stringent approach.

Home-based businesses are not uncommon - from consulting rooms, to sheds, workshops on a rural property, or lifestyle farms.

The opportunity for a home-based business to access the small business CGT concessions on the sale of their home often arises because the taxpayer’s accountant has calculated any main residence exemption applicable, applied any CGT discount available, and then, considers whether the small business CGT concession might apply to reduce or eliminate the remaining capital gain.

The absence of bright-line tests

One of the conditions for accessing the small business CGT concessions for a home-based business is that the property satisfies the active asset test.

To be considered an ‘active asset’ under section 152-40 ITAA 1997, the asset must be used, or held ready for use, in the course of a business that is carried on by the taxpayer, their affiliate or their connected entity. And, the property must be an active asset for at least half of the ownership period or for 7.5 years if it has been owned for more than 15 years.

There are no bright-line tests for section 152-40. The law does not require a property to be wholly used in business in order to be an active asset and as such, a property that is partly used for business and partly used for private purposes might still be an active asset. A property is either an active asset or not, there is no apportionment between business and private use.

The Administrative Appeals Tribunal decision in Rus v Commissioner of Taxation [2018] AATA 1854 considered this issue. In that case, the taxpayer owned a 16-hectare rural property which contained two houses and a shed. The shed with an office and shelves was used by a plastering business for storage of tools and equipment. The office of the business operated from the main residence, but most business activities were conducted off-site. The vast majority of the property, approximately 90%, was vacant land.

The AAT concluded that the property was not an active asset as the extent of business use was minor when viewed against the property as a whole. The overall character of the land remained predominantly non-business or private.

The ATO’s more stringent position

If a portion of a property is designated for business use, it’s often assumed that it will qualify as an active asset. Indeed, some ATO earlier guidance may initially suggest this outcome - ATO ID 2002/753 states that the definition of ‘active asset’ does not require exclusive use of the asset for business purposes. For example, if the taxpayer's interest in the property is 30%, and the business use is 20%, the taxpayer may still use its entire interest in the property as a replacement asset.

Similarly, the ATO’s examples in its guidance dealing with mixed use assets and subdivided land suggest that the land may still be an active asset even if an insignificant portion of land was used for business purposes.

However, there has been a noticeable tightening in the ATO’s approach to the active asset test, in particular for home-based business properties. Consistent with Rus, the latest guidance from the ATO emphasises that the active asset test must be applied to the property as a whole, not just a portion used in the business.

“As the active asset test must be applied to the asset as a whole, not just the portion used in business, in practice it will be rare that a property whose main use is private (as a home) will qualify.”

The ATO guidance includes an example of a property on a small block amongst other businesses, where a long-term business occupies the ground floor (50%) and a private residence sits above. In that scenario, the property qualifies as an active asset.

But what would happen if the same building was on a larger block of land not used directly by the business – like some suburban dentists and physiotherapists? Would the presence of business signage on the property make a difference? Would that qualify the land as being used in carrying on the business therefore an active asset?

Some uncertainty about the interpretation and application of section 152-40 in practice remains.

Key risk factors for home-based business properties

Properties with the following features are at high-risk of failing the active asset test:

• Large land size with only a small portion of business use

• Home-based businesses with significant private use

• Passive or low-intensity use (e.g., storage only)

• Business activities conducted mostly off-site

• Rural or ‘lifestyle’ properties with limited commercial activity

• A large proportion of land not directly generating income

• No visible business presence at the property (e.g., no business signage, limited customer and supplier interaction at the property)

• Business activities that could easily be conducted elsewhere (i.e., the property is not integral to business operations)

When to seek a private ruling

If there is uncertainty as to whether the client’s property will qualify as an active asset, particularly where the capital gain is significant, it might be more appropriate to seek a private ruling from the ATO.

Some of these circumstances might be where:

• Business use is substantial but clearly not dominant, e.g., where approximately 30%-40% of the floor area is used for business purposes

• Part of the home has been modified to include purpose-built workshop, warehouse or storage facilities for business use

• The level of business use changes over time, with business use increasing or decreasing during the ownership period

• A large property with substantial infrastructure (e.g., dedicated office, consulting rooms) where vacant land is occasionally used for storage or customer parking

• A subdivided property where one lot is primarily used for business purposes (e.g., a workshop), but intensity of business use may be insufficient to clearly satisfy the active asset test.

In these cases, a private ruling can provide certainty for the client on their CGT position.

Need more?

Reach out to Linda Jing for assistance to review your client's position.

t +61 2 9221 6666
e linda.jing@hayesknight.com.au

References

• ATO: Home-based business and CGT implications
• s152-40 ITAA 1997