In a recent journal article, we explore both the policy underlying the capital gains tax (CGT) main residence exemption and the legislative provisions introduced to give effect to that policy.
We argue that the underlying policy is unclear and uncertain. It has failed to provide an appropriate set of foundations for the CGT main residence exemption, owing more to political pragmatism than to any notions of equity, efficiency or simplicity.
These poor foundations have, in turn, meant that the legislative provisions are overly complex, uncertain and inconsistent. The provisions often do not operate effectively or as intended, except in the simplest of cases.
A very generous exemption
Although lower than at any time since the Australian Bureau of Statistics started the data series in 1994, home ownership in Australia remains relatively high.
In 2019-20, roughly two thirds (66.3%) of Australian households owned their own home. This is very similar to home ownership in other comparable countries, such as the United Kingdom (63%), New Zealand (64.5%), the United States (65.7%) and Canada (66.5%).
However, all of these countries including Australia are also experiencing problematic and potentially harmful outcomes related to home ownership. This includes rising housing unaffordability, wealth inequality, as well as intergenerational inequity.
The exemption for the family home impacts tax revenue significantly. Treasury estimates indicate that the revenue forgone in 2023-24 from the exemption totals $47.5 billion.
This is a significant sum that is foregone in support of the notion that widespread home ownership is a political goal that should be fiscally encouraged. Indeed, given that the exemption is not just limited to the sale of the first home, opportunities such as ‘flipping’ and ‘upscaling’ are also effectively encouraged.
Policy considerations
Despite the clear political rationale for some exemption from CGT on the disposal of the family home, there is considerable debate about whether it is appropriate on economic or tax policy grounds. While existing homeowners, who otherwise would be subject to CGT on sale, may appreciate the concession, it is predicated on uncertain, even shaky, foundations so far as equity, efficiency and simplicity considerations are concerned.
The exemption runs counter to the equity principle on several levels. It very obviously offends the principle of horizontal equity as homeowners obtain an advantage that is not available to those in rented accommodation. Critics also point out that the exemption is of far more value to high income taxpayers than to lower income taxpayers, thus offending the principle of vertical equity. The main residence exemption also falls short in relation to notions of intergenerational equity.
The rapid growth in house prices in Australia and around the world in the last few decades, is attributable, to some extent at least, to the existence of the very generous tax shelter treatment afforded to the family home. The exemption not only makes it increasingly difficult for low-income households to gain a step on the housing ladder, it also disproportionately disadvantages younger generations vis-à-vis their older peers.
Perhaps most critically in the Australian context, the growth of house prices well beyond the rate of household income growth is fuelling intergenerational inequality and destroying social mobility.
On efficiency grounds, the main residence exemption has biased investment away from productive commercial and industrial activities and into owner-occupied housing. This in many cases leads to over-investment in houses relative to the occupants’ real needs. The exemption also encourages over-capitalisation in main residences since any increase in their value is tax free.
Moreover, over-investment in housing, with consequent increases in house prices, has meant that homes have become unaffordable for all but the very wealthy or very fortunate younger members of society.
The main residence exemption also adds significantly to the complexity of the Australian CGT regime. If complexity is measured by reference to the length of legislative provisions (a crude but useful measure), the exemption must rank highly. More pages of the Income Tax Assessment Act 1997 (ITAA 1997) are contained in the subdivision devoted to this exemption than to any other of the core provisions of the CGT regime.
The main residence exemption provisions are among the most difficult and complicated of all the CGT provisions to navigate, unless the scenario under consideration ‘fits neatly’ into the provisions of the legislation.
Conclusion
In conclusion, Australia’s main residence exemption is not entirely ‘fit for purpose’, and its foundations may be less stable than should be the case. There are several reasons for this unsatisfactory situation, including confused and uncertain policy parameters, and poor legislative drafting.
In addition, the impact of compliance cost savings measures made to the regime in 1996-97 may not have been fully thought through and interactions with other provisions not made clear. This includes the use of ‘precipice’ tests (for example, looking at circumstances just before a CGT event) which may not interact well with other provisions and are capable of manipulation.
Notwithstanding the strong equity, efficiency and simplicity arguments against the family home exemption, and despite the provisions not being ‘fit for purpose’, it is highly unlikely that any mainstream politician or political party would suggest that the exemption should be removed, whether in Australia or any other country. The dream of owner-occupied housing represents a national aspiration in Australia, as elsewhere, and support for owner-occupied housing holds a high priority for leaders of all political parties. Therefore, it is unlikely to be removed.
There may, however, be stronger arguments in favour of adapting or curtailing the concession. This could be done in any one of a number of ways. One possibility lies in ‘capping’ the amount of the gain that is exempt (as in the US and South African provisions). An alternative to ‘capping’ is to introduce a form of rollover relief (as in some of the Scandinavian and other countries such as India) where the exemption applies only if capital proceeds from the sale of the family home are used to purchase a new family home.
A further alternative may be to provide an exemption only in certain circumstances, such as relocating for employment or business or selling and relocating because of ill-health. And finally, the government may also consider leaving the exemption entirely intact but accompanying it with a progressive annual property tax designed to claw back some of the benefit of the exemption.
We argue it may be possible to reformulate the current main residence exemption provisions in such a manner as to provide firmer foundations through greater certainty in their operation and interpretation. Revisiting the technical provisions of the exemption with less focus on the prevention of abuse and more attention to the intention of the provisions to provide a sensible measure of relief in an equitable, efficient and less complex manner might indeed give credence to the apparent Confucian quote that ‘the strength of a nation derives from the strength of the home’.
Citation: Davies, Glenn & Evans, Chris, (2024), CGT Exemption on Family Home: Firm Foundations or Uncertain Footings?, Austaxpolicy: Tax and Transfer Policy Blog, 2 December 2024.
Glenn Davies is a sessional lecturer in tax at the University of New South Wales.
Chris Evans is an Emeritus Professor in the School of Accounting, Auditing and Taxation at UNSW Australia and an Extraordinary Professor in the Department of Taxation at the University of Pretoria, South Africa. He has published extensively on all aspects of taxation, but particularly comparative taxation, capital gains tax and tax administration.