Capital Gains Tax (CGT) and Options to Buy or Selling Properties – Tips and Traps

⚠️ Important Timing Considerations – Especially Around Financial Year-End

Scenario Overview

• Option Granted: 1 May 2024
• Option Fee: $50,000 (non-refundable) to purchase a commercial property for $2,000,000
• Option Exercised: 10 August 2024
• Contract Formed (on exercise): 10 August 2024
• Settlement Date: 15 October 2024
• Seller Purchased Property: 1 January 2015 for $1,000,000
• Financial Years:
  • 2023–24 ends 30 June 2024
  • 2024–25 runs 1 July 2024 – 30 June 2025

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🧑‍💼 BUYER (Grantee of Option)

✅ CGT Acquisition Date

• The asset is acquired on 10 August 2024, the date the option is exercised and the contract is formed.
• This date is critical for:
  • Starting the 12-month holding period to qualify for the 50% CGT discount.
  • Determining the cost base timing.

💰 Cost Base for the Buyer

• Purchase price: $2,000,000
• Option fee: $50,000
• Other costs (legal, stamp duty, etc.): $100,000
• Total cost base = $2,150,000

🗓️ The 50% CGT discount will only apply if the asset is sold on or after 10 August 2025.

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🧑‍💼 SELLER (Grantor of Option)

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Event 2: Sale of Property – CGT Event A1

• Occurs: 10 August 2024, the date the contract is formed (even though settlement is later).
• The CGT event A1 is triggered in the 2024–25 income year.
• Proceeds: $2,000,000
• Cost base: $1,000,000
• Holding period: >12 months → 50% CGT discount applies

🧮 Capital Gain (2024–25):

• Gross capital gain: $1,000,000
• Discounted capital gain: $500,000

Note: The option fee is not added to proceeds again, as it’s already taxed separately under Event D2.

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📘 CGT Summary by Financial Year

Party	CGT Event	Date	FY Assessed	Proceeds	Gain	Discount
Seller	Option Granted (D2)	1 May 2024	2023–24	$50,000	$50,000	❌ No
Seller	Property Sale (A1)	10 Aug 2024	2024–25	$2,000,000	$1M → $500k	✅ Yes
Buyer	Acquisition Date	10 Aug 2024	2024–25	$2,150,000 (incl. option fee)	N/A (cost base only)	N/A
Buyer	CGT Discount Eligibility	On resale after 10 Aug 2025	Future sale year	N/A	Depends on resale timing	✅ if held 12+ months

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⚠️ Key Lessons

1. The buyer’s acquisition date is the contract date from option exercise, not when the option was granted.
2. The seller pays CGT in two different income years:
   • Option fee in 2023–24 (CGT Event D2).
   • Sale of property in 2024–25 (CGT Event A1).
3. The option fee is taxed separately and not included in the sale proceeds.
4. The 50% CGT discount depends on holding period from acquisition/contract date—not from the option date.

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🏠 vs 🏢 CGT Treatment of Options: Residential vs Commercial Property Sales

🔷 1. CGT Treatment of Options – Generally the Same in Law

The basic CGT rules around options—i.e., CGT Event D2 for granting an option, and CGT Event A1 for selling the underlying asset once an option is exercised—apply consistently across all asset types, including:

• Residential property
• Commercial property
• Shares or other CGT assets

So, in terms of legal treatment, there is no distinction in how options are taxed solely because the underlying asset is residential or commercial.

🔷 2. Practical Differences – Substance Over Form Issues

However, there are significant practical and compliance differences, especially with residential property, where capital gains tax (CGT) exemptions or concessions may apply.

• Main Residence Exemption (MRE): Whether someone qualifies for a full or partial CGT exemption (e.g., under the six-year rule) depends on the date of contract, which could be manipulated using option structures.
• Foreign Residents and MRE: As of 1 July 2020, foreign residents lose access to the MRE unless certain life events apply. The ATO will assess residency status as of the contract date (which may follow an option period).

Thus, in residential cases, timing matters significantly more for whether an exemption applies, and this invites greater scrutiny.

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⚠️ ATO Concerns – $1 Options to Manipulate CGT Timing

Yes, the ATO is very aware of potential abuse where options with token consideration (e.g., $1) are used to delay contract formation and shift CGT events into a later income year.

🎯 Key ATO Concerns:

• Deliberate timing manipulation: A seller may grant an option on 30 June for $1, allowing the buyer to exercise on 1 July, artificially deferring the CGT event to the following income year.
• Lack of commerciality: If the option fee is nominal or not arm’s length, the ATO may argue that the transaction lacks commercial substance.
• Anti-avoidance provisions: The ATO may invoke Part IVA of the ITAA 1936 (the general anti-avoidance rule) if the dominant purpose of the arrangement is to obtain a tax benefit by deferring capital gains tax (CGT).

🧾 ATO Guidance:

• TR 97/3 and TD 2001/27 make it clear that the CGT event occurs when a contract is entered into, not when an option is granted.
• However, if the option is not on commercial terms, or the parties are not dealing at arm’s length, the ATO may re-characterise the arrangement.

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✅ Best Practice Tips

1. Use commercial option terms: The option fee should reflect market value (e.g., 1–5% of purchase price), especially in related-party transactions.
2. Avoid nominal options near 30 June: These raise immediate red flags with the ATO.
3. Document genuine commercial reasons for the use of an option (e.g., buyer needs time for DA approval, finance, or regulatory approvals).
4. Apply Part IVA lens: Always assess whether the arrangement, viewed holistically, has a dominant tax avoidance purpose.
5. Watch for developer timing tactics: For instance, rolling options across tax years to delay capital gains tax (CGT) on rezoned land can attract scrutiny.

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🧑‍⚖️ Example of Risky Structure

On 30 June 2025, John grants his family trust an option to buy his investment property for $2 million with a $1 option fee, exercisable on or after 1 July 2025.

• ATO likely view: This is an artificial timing mechanism with no commercial purpose other than to defer CGT into 2025–26.
• Risk: The ATO may disregard the option and treat the CGT event as having occurred on 30 June 2025 under Part IVA or look-through principles.

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👇 Bottom Line

• CGT rules for options apply equally to all property types; however, residential properties, especially those with MRE implications, receive more ATO attention.
• Token or $1 options used to push CGT into a future year can trigger anti-avoidance scrutiny, especially if not at arm’s length or without genuine commercial reasons.
• Always seek professional advice before using options near year-end to ensure compliance with both technical and anti-avoidance provisions.

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✅ Best Practice: How to Use Options Safely

If you’re considering using an option as part of your property transaction:

✔️ Ensure the option is commercially justifiable
✔️ Avoid nominal option fees (e.g., $1) near 30 June
✔️ Document the commercial reasons for using the option (e.g., time for finance or planning approval)
✔️ Be especially cautious with related-party transactions (e.g., family trusts or companies)

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📞 Need Help?

If you’re planning to use an option agreement—particularly near the end of the financial year—don’t hesitate to get in touch with us before signing. We’ll help ensure the arrangement is compliant, commercially sound, and tax-efficient.

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