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CGT moving from the US to Australia watch out for three things.
CGT Moving Back To Australia
When you relocate from the US to Australia, two things you need to watch out for are CGT and 401k retirement funds. Let’s cover US 401k Retirement funds in the next episode.
Today let’s talk with Bradley Murphy and Darren Catherall of Murphy Tax Lawyers and Advisors in Sydney about the CGT implications when you move from the US back to Australia. And whatever we discuss with respect to Australian tax will apply to relocations from other countries as well. So for Australian tax – disregarding any treaties – it doesn’t matter where you are coming from.
Here is what we learned but please listen in as Bradley and Darren explain all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
CGT Moving Back To Australia
What happens when you move from the US to Australia and become an Australian tax resident?
US Citizen or Greencard Holder
The first big question is whether you are a US citizen or Greencard holder.
If you are NOT, you just have the transition to sort out but after that you are free of the US tax system.
If you are, you face double taxation all the way until you either renounce your US citizenship and pay repatriation tax or move back to the US. Yes, there is the US Australian double tax agreement. Short ‘DTA’. The US calls it ‘The Treaty’. But as you will hear in this episode, there are quite a few scenarios where you run a real risk of being taxed twice.
Double Taxation
When you just have one country wanting to tax certain income, you don’t need a DTA. There is no double up.
You need a DTA when there is. When two or more countries want to tax the same income.
Most countries have two gateways into their tax system. Residency and source of income. The US has three. Residency, source of income and….citizenship.
And it is because of this, that all tax treaties with the US have a lot of heavy lifting to do. Because whenever a US citizen or Greencard holder moves to another country outside the US, you have double taxation. The non-US country wants to tax that poor fellow based on residency. And the US taxes him or her on citizenship.
And so the US AU treaty gets a heavy work out whenever you are a US citizen or Greencard holder living in Australia.
Taxing Rights
DTAs decide which country gets the taxing rights when two countries want to tax. For that you need to look at each income and see where the source is.
Usually, the taxing right is with the country where you:
Work for employment income.,
Own real property for rental income and CGT.
Reside for capital gains from personal property.
Receive dividend and interest income from.
The other country will then tax the same income but give a foreign income tax offset – the US calls this a foreign tax credit – for the tax paid in the country with the taxing rights.
US AU DTA
Just like any other double tax agreement, the US AU DTA allocates taxing rights when both countries want to tax the same income.
And that usually works well with most DTAs, but you can run into the following issues:
Timing
Timing is an issue for all DTAs. Especially with respect to capital gains tax which is often about a one-off event and a lot of tax.
What if the country with the taxing rights hasn’t taxed the income yet and so you can’t claim a foreign tax credit in the other country yet that is already taxing this income?
For an answer, you need to go back to the domestic tax rules to see whether and when you can claim a credit.
Savings Clause
You won’t find a Savings Clause in any other Australian DTA apart from the one with the US.
The Savings Clause in Article 1 (3) of the US AU DTA is crucial for the US. Without it, the US would not be able to tax its US citizens living in Australia on worldwide income based on citizenship.
Most countries tax on residency. And so does the US. The US taxes on a residence basis – if you pass the substantial presence test – like everybody else. But in addition – as you know – the US also taxes based on citizenship and visa status.
And hence you get the Savings Clause in Article 1 (3) of the US AU DTA, where it says – paraphrased:
(3) …the US may tax its residents …and … citizens, as if this Convention had not entered into force.
This clause protects the US’ right to tax its citizens on worldwide income even if they don’t live in the US.
However, this is curtailed by Article 1 (4) – the savings clause can’t prevent mutual agreements.
US State Taxes
The US states don’t give a foreign tax credit for Australian income tax you pay. So if you have a US citizen living in California who sells an Australian property, they get a credit for Australian taxes paid for their US federal tax but not for US state taxes.
The DTA applies to both federal and state income taxes. So Australia will give a credit for both US federal and US state taxes. But the US states don’t give a credit for Australian income tax paid.
Tiebreaker Rules
The US AU treaty includes a tiebreaker rule for individuals but not for entities. This test is really important for Australians moving to the US for less than 2 years under a 3E visa.
Effective Management Tiebreaker Clause
Most treaties include an effective management tiebreaker clause for dual residency entities. Australia’s treaty with the US doesn’t.
That is an issue especially for Australian-controlled pass-through entities like LLCs. The US says that it is a domestic person since established in the US. And Australian says that it is an Australian tax resident since its central management and control is in Australia.
The US AU treaty doesn’t address that issue.
Relocation
The first thing you look at when you move back to Australia is dates. When does your tax residency start in Australia? It usually is the day you land in Australia. So in the first year you are a part-year resident.
That is quite a complex area since often quite vague and subject to interpretation.
Rebasing of CGT Cost Base
On the day you arrive back in Australia, all your assets – apart from Taxable Australian Property that never left the Australian tax system – will have a rebased cost base at market value of that day.
US Exit Tax
The US doesn’t have an exit tax / repatriation tax – for assets that are not US land – as long you don’t relinquish your Greencard or citizenship. So there is no deemed disposal of assets when you leave the US as long as you don’t change your US tax status as a domestic person.
There is a repatriation tax – another word for exit tax – if you relinquish your US citizenship or Greencard. If you do that, then there is an exit tax as long as your assets exceed USD 2m and you held the Greencard for more than 8 years. An exit tax on the full market value of your assets.
So that means – as long as you don’t trigger US exit tax – you get the entire capital gain tax-free – the capital gain between purchase while in the US and return to Australia.
So don’t sell your assets while still in the US. First move back to Australia, get out the US tax net and then sell with your new Australian cost base.
Australian Exit Tax
Just quickly looking at outbound relocations to the US: Australia has an exit tax but there is Article 13 (6), which allows you to move the taxing rights to the US. That is highly relevant for a share or crypto portfolio.
If you defer the Australian exit tax, then the US would tax the full capital gain. However, the US tax on capital gains is lower than in Australia.
If you don’t defer, then you get the market value cost base in the US at the time of relocation as per Article 13 (5).
Superannuation
Don’t contribute to Australian super while in the US. Employer superannuation guarantee might still be ok – but even for that opinions divide. But definitely don’t make any personal or non-concessional contributions to your super while in the US.
If you do – your super fund is potentially treated as a foreign grantor trust and your contributions as well as any realised and unrealised net gains are treated as income.
Passive Foreign Investment Companies
If you hold a Passive Foreign Investment Company (PFIC) as a US citizen or Greencard holder – so for example an Australian Pty Ltd or trust mainly holding passive investments – you also face potential issues.
Australian Taxable Real Property
Australian taxable real property (TARP) never left Australia. TARP never leaves the Australian tax net. So when you come back to Australia from the US, your TARP is still there at its original cost base when you bought it.
The same applies to US real property. It stays in the US and is taxed first and foremost in the US and then in Australia as part of your worldwide income. But the first taxing right is with the country where the property is.
Main Residence Exemption
Australia and the US both have a main residence exemption.
For Australia, you must be a resident at the time of sale. It doesn’t matter if you were a non-resident for some or most of the ownership period. The only thing that matters is that you are a resident at the time of sale. So don’t sell while you are in the US. Sell when you are back and an Australian tax resident.
Something that is often overlooked: You can apply the Australian main residence exemption to your main residence in the US. The Australian 6-year absence rule still applies, even if the property is overseas.
So you can return to Australia, rent out the US residence for a couple of years and then sell – CGT free.
But you have to look out for the US main residence exemption, since there is a timing mismatch.
For the US principal residence exemption, the 2 Out Of Five Year Rule applies To qualify you must have lived in your principal residence for 2 of the past 5 years. If you are out of that 2/5 year window, then you don’t get the American exemption on your US primary residence.
So make sure you sell your US residence within 3 years after moving back to Australia.
So there is a timing mismatch between the US and Australia. Australia gives you 6 years but the US only gives you three years.
Foreign Exchange Gains and Losses
If you have a mortgage on a property in the US, when you are back in Australia, you might end up with an FX gain or loss which will hit your Australian tax return.
Summary
So the first big question when you return from the US to Australia is CGT. And to be more exact three CGT issues to look out for:
1 – Repatriation Tax
Possible US exit tax on your US assets. The US calls this repatriation tax – so repatriation tax applies if you relinquish your citizenship or your Greencard and exceed certain asset and income thresholds or your tax filings for the past five years are not up to date.
But if this doesn’t apply to you, for example, because you are not a US Citizen and you didn’t have a Greencard to start with or your assets and income are below the thresholds, then you don’t need to worry about repatriation tax or exit tax in general. So unless you qualify for repatriation tax, your assets will leave the US tax-free. So that is good news.
2 – Adjustment of Cost Base
The second thing to worry about when you relocate from the US back to Australia is the adjustment of your assets’ cost bases to market value. But that is really just an admin task and doesn’t affect you until you sell those assets. Make sure you collect evidence to prove the market value of your assets at the time of entry.
The good news is that if US repatriation tax doesn’t apply, then you get the entire capital gain from purchase to the date of your return to Australia – you get that entire capital gain tax-free.
3 – Main Residence
And the third thing to look out for is the sale of your main residence either in Australia or the US.
And this can get confusing so let’s say we have to Australians returning from the US back to Australia. Sally bought a house in the US, and Sheila only rented in the US and has her main residence in Australia.
So let’s start with Sally and her main residence in the US. If Sally sells her main residence before she leaves the US, then no CGT in Australia since the land is neither Taxable Australian Real Property (TARPP) nor is Sally a tax resident, so Australia has nothing to do with Sally’s home in the US.
If Sally sells her US home after returning to Australia, then she can still claim the US principal residence exemption in the US as long as she sells within three years under the 2 in Five Year Rule. And in Australia Sally can claim the main residence exemption under the six-year absence rule. So the important point is that in the US Sally only has a three-year window to sell.
Now to Sheila who kept her Australian home and just rented in the US while she was there.
If Sheila sells her home while still in the US, then she will pay full CGT since she is not an Australian tax resident but the property is TARP. And as you know you only qualify for the main residence exemption if you are an Australian tax resident at the time of sale. So if Sheila sells before she comes, Australian CGT.
If Sheila sells her Australian home after she comes back, no CGT under the main residence exemption unless Sheila rented her Australian home out for more than six years so exceeded the six-year absence rule. If she had kept it empty while away, no CGT.
Final Comment
So this is a short overview of what we took away from this interview. Just a quick brainstorm. Please listen to the actual interview since Brady and Darren explain the issues in a lot more depth.
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 13 December 2022
