Downsizer super contributions: Common misunderstandings

By Stuart Sheary, Senior Technical Manager

Downsizer super contributions have been very popular, surpassing 1 billion dollars in contributions in the first year it became available. In most cases, eligibility is straight forward, however some client cases have nuances which can complicate the eligibility assessment process.

The following article briefly explores some common misunderstandings. Understanding the downsizer contribution rules allows you to identify more opportunities and ensure your advice is technically accurate.

Making an ineligible downsizer contribution

Clients who do not get advice before making a downsizer super contribution are at particular risk of making an ineligible contribution. The ATO downsizer contribution into superannuation form, necessary to make a downsizer contribution, although it provides little guidance on eligibility.1 In this form, it is assumed the client understands the rules and they must declare they satisfy the downsizer requirements.

Where your client makes an ineligible downsizer contribution, the outcomes and consequences can vary depending on whether the fund can accept personal contributions as well as your client’s available non-concessional contribution cap. Penalties for making a false and misleading statement may also be applied if an incorrect declaration is made.2

Through their verification process the ATO may contact your client for more information to confirm eligibility. If the ATO deems a contribution to be ineligible, then they will contact the super fund to reclassify the contribution.

If your client is not eligible to make non-concessional super contributions due to age or failing the work test or work test exemption, the super fund will return the contribution within 30 days of becoming aware of its ineligibility.

If your client is eligible to make a non-concessional contribution, the fund will not automatically return the contribution. This may result in the client exceeding their non-concessional contribution cap.

Case study

Rachna (age 66) and Raj (age 76) misunderstand the downsizer rules and upon selling their investment property in Woollahra each make a $300,000 downsizer contribution to super in 2020/21 financial year.

The couple have not applied the main residence exemption on the sale of the property in their income tax return. The ATO contact the couple for clarification and the couple confirm the property was never used as their main residence.

The ATO inform their super fund that the couple are ineligible to make a downsizer contribution and ask the fund to return or reclassify the contribution. The following will apply to Rachna and Raj.

Rachna

Rachna was 66 at the time of the contribution, under SISR 7.04 (1) the fund can accept personal contributions such as non-concessional contributions. The fund reclassifies the ‘downsizer contribution’ to a ‘personal contribution’. As no deduction has been claimed, the personal contribution will count towards her non-concessional contribution cap.

Assuming her Total Super Balance is below $1.6M (at 30 June 2020) her non-concessional contribution cap is $100,000.3 She has therefore exceeded her non-concessional contribution cap by $200,000.

She will have two options. The first option is to withdraw the excess NCC together with 85% of the associated earnings (which is the default option if no action is taken). Under the second option Rachna can elect to keep the excess non-concessional contribution in super and be subject to excess non-concessional contributions tax of 47%.

At the time of writing, the Treasury Laws Amendment (More Flexible Superannuation) Bill 2020 is yet to be passed. The Bill proposes to extend the bring-forward rule to clients who are age 66 at anytime during the financial year. If this Bill is passed and becomes law then Rachna may be eligible to utilise the bring-forward rule (subject to having a total super balance below $1,400,000) and would not have an excess non-concessional contribution cap issue if the downsizer contribution is reclassified.

Raj

Raj is over age 75. The only contributions the super fund can accept for Raj are Downsizer contributions and Superannuation Guarantee.

As the contribution classifies as neither a Downsizer contribution or an employer Superannuation Guarantee contribution the fund returns the money to Raj within 30 days of becoming aware of the ineligible contribution per SISR 7.04 (4).

Clients must be at least 65 at time of contribution

There is sometimes a misunderstanding as to when a client needs to satisfy the age 65 requirement to make a downsizer super contribution. Clients do not need to be age 65 at the time of exchanging sale contracts nor do they need to be age 65 at time of settlement. Clients must be at least age 65 at the time of making the downsizer contribution. As the downsizer contribution can be up to 90 days following settlement it may be possible to be aged 64 at settlement and still satisfy the age requirement so long as a client’s 65th birthday is within 90 days of settlement and they make the contribution after their 65th birthday. The ATO can extend the 90-day period to make a downsizer super contribution, however, an extension will not be granted where the reason is to satisfy the age rule.

TechTip: Remember clients must be age 65 at the time of the downsizer super contribution. There is no upper age limit or work test requirement.

10-year ownership test

A common mistake is to fail the 10-year ownership requirement. This ownership period is measured from settlement of the purchase contract, until the settlement of the sale contract .

This requirement is sometimes forgotten or misunderstood. Whilst a CGT event arises upon exchanging contracts, ownership does not ordinarily pass until settlement. As the ownership period needs to be at least 10 years it is necessary to confirm that at least 10 years have passed between settlement of the purchase contract and settlement of the sale contract4.

Vacant land can still count towards the 10-year ownership test, however, upon sale there must be a dwelling that qualifies for at least a part main residence CGT exemption. This means eligibility is not impacted by delays in the construction of a new building on a vacant block or knockdown rebuild so long as the time of sale there is a dwelling eligible for the main residence exemption.

Downsizer contributions - ownership period

Subdivision of family home

Your client’s home may be on a block which can be subdivided. If a client subdivides and sells their new block, they may wish to make a downsizer super contribution. In this scenario eligibility will come down to whether the parcel of land they are selling has a dwelling and is eligible for at least a part main residence exemption.

To this end if your client subdivides their property and sells the block which contains their original dwelling, they may be eligible to make a downsizer super contribution.

If instead they sell the second block with no dwelling, they will not be eligible to make a downsizer super contribution. A requirement under downsizer rules is that there is a sale of a dwelling which must also qualify for a part or full main residence CGT exemption.

Gifting the property for no consideration

The value of capital proceeds, subject to a limit of $300,000, can be contributed into super as a downsizer contribution. In the context of downsizer super contributions capital proceeds are limited to gross sale proceeds and the market substitution rule5 does not apply6.  This amount is not reduced by any loan against the home, agent fees and commissions etc.

Where there are no sale proceeds from the disposal of the home, the client will not be eligible to make a downsizer super contribution. Situations where this might arise are when the home is gifted for no consideration to a family member such as spouse or child.

Tech Tip: Capital proceeds relates to the gross sale proceeds and is not reduced by any loan against the home that might be repaid, agent fees or commissions.

Failing to qualify for at least a part main residence exemption

For a property to be eligible under downsizer rules, it is necessary for the client to be entitled to disregard part, or all of any capital gain, under the main residence CGT exemption. If the home is a pre CGT asset it may still be eligible assuming it would have been entitled to at least a partial main residence CGT exemption had it not been a pre-CGT asset.

To this end the sale of an investment property that at no time had been used as a main residence would not entitle a client to make a downsizer super contribution.

Similarly, where a client disposes of a former home that they lived in before becoming a member of a couple and the other member of a couple had never lived in the property then the spouse who had never lived in the property would not be eligible to claim the main residence exemption and would not be eligible to make a downsize contribution.

TechTip: A spouse that does not have an ownership interest in the residence may satisfy the downsizer contribution requirement if they would have been entitled to at least a part main residence exemption if they did have ownership in the property. This requires the spouse to have lived in the property for at least a short period of time.

Conclusion

In many cases, confirming a client’s eligibility is straight forward. Where there is uncertainty, your client may seek confirmation from the ATO using their early engagement advice process or seek a private binding ruling.

For a refresh on eligibility, please see Strategy Guide 20 – Downsizer Contributions which can be found on the IOOF Fast Fact Finder.

An eligibility checklist for downsizer super contribution is following and can assist to confirm eligibility.

Downsizer checklist
Your client is age 65 or over at the time of making the contribution.
Your client or their spouse has sold an interest in a dwelling they (or a former spouse) have held for 10 years or more.
Your client’s dwelling is in Australia and is not a caravan, houseboat or other mobile home.
The gain/loss from the sale is at least partially disregarded under the main residence capital gains tax (CGT) exemption or would be if it was a CGT asset rather than a pre-CGT asset.
The contribution is made within 90 days of receiving the sale proceeds.
The downsizer contribution is the lesser of $300,000 and the proceeds of sale. For a couple, it is capped at $300,000 (each) and total downsizer contribution cannot exceed the couple’s combined capital proceeds.
The client has not made a downsizer contribution from the sale of another home.
The downsizer contribution into super form is given to the super fund at or before the time the contribution is made.

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1. Super funds may produce their own downsizer declaration forms.
2. ATO GN 2018/2
3. Based on legislation at the time of writing it is a requirement to be age 64 or less at some time in the financial year to trigger the bring-forward rule.
4. LCR 2018/9, paragraph 34.
5. The market substitution rule which can apply when calculating capital gains stipulates that deemed capital proceeds can be adjusted where two parties are not acting at arm’s length transaction and the transaction is not at market value.
6. s292-102(3A) ITAA 1997.

More information

If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.

Disclaimer
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.