CGT Reform and Holiday Homes: Why the Third Element of Cost Base Matters Most Here

General information only. This is not tax or financial advice. Consult a registered tax agent for advice specific to your situation, especially before relying on the main residence exemption or valuing a property with no recent sale or rental history.

Every capital gains tax cost base is built from up to five elements: (1) acquisition costs, (2) incidental costs of buying and selling, (3) costs of owning the asset, (4) capital costs to increase or preserve value, and (5) capital costs to defend title. For an investment property with a clean rental history, element 3 barely matters — mortgage interest, rates, land tax and insurance are claimed as tax deductions every year, and a cost you have deducted (or could deduct) cannot also be added to your cost base. For a genuine holiday home that has never produced assessable income, or one that has just lost its holding-cost deductions under the ATO’s 2026 “leisure facility” crackdown, there is no annual deduction to claim instead — so element 3 becomes the dominant, sometimes the only growing, component of the cost base.

That distinction, largely invisible while the 50% CGT discount applied to the whole gain regardless of its composition, becomes directly consequential under the enacted CGT reform. The Acts that abolished the discount from 1 July 2027 replace it with CPI cost base indexation — but not for every element. This article is the one piece of reform coverage that walks through exactly what that carve-out means for a holiday home, and what else changes for owners of non-income-producing property in the run-up to 30 June 2027.

The short version. From 1 July 2027, cost base indexation applies to elements 1, 2, 4 and 5 of your cost base — but not element 3, the costs of owning the asset (interest, rates, land tax, insurance, repairs and maintenance not otherwise deductible). A holiday home’s cost base leans on element 3 far more heavily than an investment property’s does, because those costs were never deductible in the first place — and from 1 July 2026, the ATO’s “leisure facility” ruling denies the deduction to an even larger group of holiday-home owners, pushing more of their holding costs into the very element the reform then excludes from inflation protection. Element 3 only exists at all for properties bought after 20 August 1991 — an older holiday home is untouched by this specific issue. If your holiday home was ever your main residence, decide now (in substance, even though the formal election is made at sale) whether you expect to lean on the main residence exemption, because that decision determines whether you need 1 July 2027 valuation evidence — and a holiday home with no rental appraisal history is the hardest kind of property to value retrospectively.

For the reform’s core mechanics, see 50% CGT Discount Reform: Cost Base Indexation Explained. For the property investor case generally, see the property investors deep dive — this article covers the distinctive angle that applies specifically to non-income-producing and mixed-use holiday property.

The third element of cost base — what it is and who it’s for

Section 110-25(4) of the ITAA 1997 defines the third element in these words: “the costs of owning the CGT asset you incurred (but only if you acquired the asset after 20 August 1991). These costs include: (a) interest on money you borrowed to acquire the asset; and (b) costs of maintaining, repairing or insuring it; and (c) rates or land tax, if the asset is land; and (d) interest on money you borrowed to refinance the money you borrowed to acquire the asset; and (e) interest on money you borrowed to finance the capital expenditure you incurred to increase the asset’s value.” Two conditions gate this element:

1. You acquired the asset after 20 August 1991. This cutoff sits directly in s 110-25(4) itself. There is no third element at all for a property bought before that date — no matter how many decades of holding costs you can document.
2. The cost has not been, and cannot be, claimed as an income tax deduction. This condition is a separate provision — section 110-45(1B): “Expenditure does not form part of the second or third element of the cost base to the extent that you have deducted or can deduct it.” This is the rule that makes element 3 almost irrelevant for a fully tax-deductible investment property and central for a holiday home: you get one benefit or the other, never both. (Note: s 110-45 by its own terms is scoped to assets acquired after 7.30pm on 13 May 1997, with a narrower extension in subsection (1A) for expenditure on land/buildings acquired before that time; every worked example below uses a post-1997 acquisition, so this scoping doesn’t affect the numbers here.) Holding costs also cannot be used to create or increase a capital loss under the general cost base rules — they only ever reduce a gain.

For a standard negatively-geared rental property, this condition is rarely triggered — nearly all of the interest, rates and insurance gets claimed as a deduction every year, so there is little left to add to the cost base. For a holiday home that is genuinely kept for private use (no rental income at all), or a mixed-use property that fails the ATO’s “mainly for income” test (below), every dollar of those holding costs that isn’t deductible is a dollar that can only ever reduce tax through the cost base — which is precisely the element the reform now treats differently to the rest.

One check worth making explicit: a holiday home is not a “personal use asset” for CGT purposes, so none of this is at risk of being disregarded outright. Section 108-20(2) defines a personal use asset as a CGT asset “used or kept mainly for your… personal use or enjoyment” — which might sound like it describes a holiday home exactly. But s 108-20(3) carves out the case that matters here: “A personal use asset does not include land, a stratum unit or a building or structure that is taken to be a separate CGT asset because of Subdivision 108-D.” A holiday house and the land under it are real property, not a personal use asset in the technical CGT sense (that category covers things like a boat, furniture or a caravan) — so the third-element mechanics above apply in full, and the (unrelated) $10,000 personal-use-asset exemption threshold that sometimes gets raised in this context simply doesn’t apply to a house.

Why holiday homes depend on this element more than any other property type

This is the structural reason the reform’s indexation carve-out matters disproportionately here: it isn’t that holiday homes are singled out by the legislation — the Act applies the same rule to every taxpayer — it’s that holiday homes are the asset class whose cost base composition makes the excluded element the biggest one.

The 2026 “leisure facility” crackdown feeds directly into this

The ATO’s ruling TR 2026/1 (finalised 20 May 2026, applying section 26-50 — “leisure facilities” — to holiday rental properties) denies exactly the same categories of cost that make up element 3: mortgage interest, council rates, land tax, insurance, and general repairs and maintenance, for any property the ATO determines is used or held mainly for holidays or recreation rather than genuinely to produce income (see Holiday Home Tax Deductions: ATO Crackdown from July 2026 for the full “mainly” test, the red/amber/green risk-zone framework, and the transitional concession for expenses incurred before 1 July 2026).

Put the two rulings together and the sequence is not a coincidence worth ignoring: from 1 July 2026, a holiday home that fails the “mainly” test loses its holding-cost deductions entirely — which means those costs now satisfy the “not otherwise deductible” condition and qualify as element-3 cost base additions for the first time (where they may not have qualified before, if the owner had genuinely been claiming apportioned deductions). One year later, from 1 July 2027, the CGT reform specifically excludes that same element from the indexation that every other cost base component receives. An owner who loses their annual deductions in 2026 and consoles themselves with “at least it builds my cost base” is banking on the one cost base element that gets the least protection from inflation under the new regime. This connection is not addressed in either ruling directly — it follows from applying the ordinary cost base rules (verified against s110-25(4) commentary this session) to the ATO’s own stated position on holiday home deductions, and it is worth understanding before assuming the crackdown is merely a wash between “deduction now” and “cost base later.”

Worked example 1 — the pre-1991 holiday home the reform doesn’t touch this way

Scenario. The Whitfield family bought a beach shack at Anglesea (Victoria) on 1 March 1988 for $65,000. It has never been rented — purely a family holiday property, used every summer since. They sell it on 1 March 2033 for $1,450,000, having spent $180,000 on a genuine renovation and extension in 2005 (a capital improvement — element 4).

Because the property was acquired before 20 August 1991, there is no third element available to the Whitfields at all, regardless of how many decades of rates notices and insurance renewals they have kept. Their cost base is simply:

• Element 1 (purchase price): $65,000
• Element 4 (capital improvement, 2005): $180,000
• Total cost base: $245,000

Both of these elements are indexed under the enacted reform. The Whitfields’ situation is exactly what the reform’s headline mechanics describe for any property — split treatment between the legacy 50%-discount portion (accrued to 1 July 2027) and the indexed reform portion (accrued after) — with no additional disadvantage from the element-3 exclusion, because there is no element 3 in their cost base to exclude. Ironically, an older, never-renovated-for-tax-purposes family shack like this one is less affected by the specific issue this article is about than a more recently purchased holiday home would be.

Worked example 2 — the post-1991, holding-costs-heavy holiday home

Scenario. Marco and Ellie bought a beach house near Lorne (Victoria) on 1 July 2010 for $650,000. They list it on Stayz but consistently block out school holidays, Christmas/New Year and Easter for their own family’s use — a pattern squarely in the ATO’s “red zone” under PCG 2025/D7 and TR 2026/1’s Example 13 fact pattern. Assume their arrangement has always been borderline, but the transitional compliance concession means the ATO does not review expenses incurred before 1 July 2026. From 1 July 2026, their holding costs (interest, rates, land tax, insurance, repairs) run at $28,000 a year and are no longer deductible. They sell on 1 July 2033 for $1,450,000.

Cost base at sale:

• Element 1 (purchase price): $650,000
• Element 3 (holding costs, 1 July 2026 to 1 July 2033, 7 years × $28,000): $196,000
• Total cost base: $846,000
• Nominal gain: $1,450,000 − $846,000 = $604,000

Split treatment. Total hold 1 July 2010 to 1 July 2033 = 23 years; pre-reform portion (1 July 2010 to 1 July 2027) = 17 years. Using time-apportionment for illustration (the Act’s primary method is market valuation at 1 July 2027 — see the master reform article for why):

• Legacy share ≈ 17/23 ≈ 73.9% → legacy nominal gain ≈ $446,356 → taxable at 50% discount ≈ $223,178.
• Reform share ≈ 26.1% → reform nominal gain ≈ $157,644.

What the element-3 exclusion actually costs them. Of their $846,000 total cost base, $196,000 (23%) is element 3 — accumulated entirely during the reform-affected period. If that $196,000 were indexed the same way as element 1 (CPI factor over the relevant years, averaging roughly 1.16 for the earliest tranche), it would be worth approximately $227,000 in indexed terms by the sale date — about $31,000 more cost base shelter than the $196,000 it is actually worth, because element 3 is carried at nominal value with no CPI uplift. At a 45% marginal rate, that difference alone is worth roughly $14,000 of additional CGT Marco and Ellie pay purely because their cost base leans on holding costs rather than purchase price. (This figure is illustrative — a full calculation apportions indexation year-by-year against each cost base element and the timing it was incurred; the point is the direction and rough scale of the effect, not a precise statutory formula.)

Compare to an equivalent investment property. A near-identical property bought the same year, rented year-round at market rates without blocking peak periods, would have claimed that same $196,000 in holding costs as tax deductions along the way — reducing annual taxable income every year instead of sitting in the cost base at all. Its cost base at sale would be dominated by the (fully indexed) purchase price and any capital improvements, giving its owner the full benefit of the reform’s inflation protection on substantially all of their cost base. The holiday-home owner gets neither the annual deduction (denied since 2026) nor full indexation protection on the consolation-prize cost base addition.

The main residence election — a decision to make in substance before 30 June 2027

If your holiday home was at some point your actual main residence — you lived in it before it became a weekender, or you plan to move into it and make it your home in retirement — the ordinary main residence rules apply on top of everything above, unchanged by the reform:

• The absence rule (s118-145 ITAA 1997, covered in full in The 6-Year Main Residence Rule) lets you continue treating a former main residence as exempt for up to 6 years if you rent it out, or indefinitely if you leave it vacant — provided you don’t nominate another property as your main residence during that period.
• The choice of which property to treat as your main residence, where you have two candidates, is formally made in the year you sell — not upfront.

Here is where the reform adds real urgency despite that formal timing rule: the practical question of whether you will likely rely on the main residence exemption for this specific property is one you effectively need to answer well before 30 June 2027, because it determines whether you bother obtaining a market valuation at that date. If you assume full exemption and skip the valuation, and it later turns out the exemption doesn’t apply in full (a second property was nominated during an overlapping period, the absence period ran past 6 years while rented, or you decide to sell a different property as your main residence instead), you will need 1 July 2027 evidence you no longer have any cheap way to get. If there is genuine doubt about which property will end up exempt, get the valuation for the holiday home regardless — it costs little now and cannot be recreated credibly later.

The valuation problem — a property with no rental history

Every asset owner needs evidence of market value at 1 July 2027 to support the split between legacy and reform treatment (or, for a pre-1985 asset, a genuinely new cost base). For most investment properties this is manageable: a recent bank valuation, a rental appraisal, or an agent’s comparative market analysis typically exists somewhere in the paper trail. A genuine holiday home usually has none of that.

• A council rates notice is not a substitute for market value. Rating valuations use a different valuation basis (often site value or capital improved value for local government purposes), are updated on the council’s own cycle rather than the property market’s, and routinely lag genuine market movements by months or years — this matters more for coastal and tourist-market property, where short-stay demand and interest-rate cycles can move prices faster than a rating authority revalues.
• Get a formal, written valuation or agent appraisal dated at or very close to 1 July 2027, not a verbal estimate or a figure reconstructed years later from memory and general market commentary.
• If the property has a short-term rental history, platform booking data and any professional appraisal obtained for insurance or lending purposes around that date can help corroborate a valuation — keep it even if you don’t think you’ll need it.
• Do this regardless of whether you expect the main residence exemption to apply — see the previous section. The cost of an unnecessary valuation is trivial compared with the cost of needing one you cannot get.

Planning levers for holiday home owners

1. Work out what your cost base is actually made of — how much is purchase price and capital improvements (indexed) versus accumulated holding costs (not indexed) — before assuming the reform treats your property like any other.
2. Check your acquisition date against 20 August 1991. If your holiday home was bought before that date, the element-3 exclusion is irrelevant to you; don’t over-plan around an issue that doesn’t apply.
3. Review your booking pattern against the TR 2026/1 “mainly” test now, not after the ATO reviews it — see the dedicated crackdown explainer for the risk-zone framework. Moving from red/amber to green (making the property genuinely available during peak periods) restores annual deductions, which is a materially better outcome than accumulating non-indexed cost base additions.
4. Get a 1 July 2027 valuation regardless of your main residence expectations. This is the cheapest insurance available against a genuinely hard-to-reconstruct valuation problem later.
5. Keep every holding-cost receipt even after deductions are denied. They still matter — just as cost base, not as annual deductions, and the reform makes accurate record-keeping of exactly when each cost was incurred more valuable, not less, because indexation timing depends on it.

FAQs

Does the CGT reform apply differently to a holiday home than to a normal investment property?

The legislation itself doesn’t single out holiday homes — the same rules (abolished discount, CPI indexation, 30% minimum tax, element-3 exclusion) apply to every individual, trust and partnership taxpayer. The difference is in cost base composition: a holiday home’s cost base leans much more heavily on the one element (ownership costs) the reform excludes from indexation, because those costs were never deductible in the first place.

What exactly is excluded from indexation?

The third element of cost base under section 110-25(4) — interest, rates, land tax, insurance, and repairs/maintenance costs that have not been, and cannot be, claimed as a tax deduction. Elements 1 (acquisition costs), 2 (incidental costs), 4 (capital improvements) and 5 (title-defence costs) are all indexed.

My holiday home was bought in the 1980s — does this affect me?

Only if it was acquired after 20 August 1991. Properties bought before that date have no third element at all, so the reform’s exclusion of that element is not relevant to your cost base (though the ordinary legacy/reform split treatment, and — for genuinely pre-1985 assets — the separate pre-CGT reset, still apply).

If the ATO denies my holding cost deductions under the 2026 ruling, do those costs at least help me later?

Generally yes, as element-3 cost base additions, provided the property was acquired after 20 August 1991 — but that cost base addition does not get CPI-indexed under the enacted reform, unlike the rest of your cost base. It is a real but partial consolation, not equivalent to the annual deduction you have lost.

Should I get a market valuation now even if I think my holiday home will be exempt as my main residence?

Yes, if there is any genuine doubt about which property will ultimately be treated as your main residence, or whether an absence period has run within the allowed limits. The formal main residence election is made at the time of sale, but the practical decision about whether to secure 1 July 2027 valuation evidence needs to be made well before that date, because the evidence cannot be recreated credibly later.

Sources

• Treasury Laws Amendment (Tax Reform No. 1) Act 2026 (No. 49 of 2026) — full text read directly from the ATO-hosted Act PDF. The new subsection 110-36(1A) states plainly: “The cost base of a *CGT asset also includes indexation of the elements of the cost base (except the third element) for the purposes of working out the *capital gain of an individual or a trust from a *CGT event happening… if… the CGT event happens on or after 1 July 2027.” The substituted section 114-1(1) repeats the same carve-out: “index expenditure incurred in each element (except the third element).” This directly confirms — from the Act itself, not only the site’s canonical summary — the central premise of this article. Royal assent 26 June 2026, per the site’s canonical CGT Reform: What Passed.
• Income Tax Assessment Act 1997 (Cth), s 110-25 — General rules about cost base — subsection (4), the third element itself, quoted directly above (interest, maintenance/repairs/insurance, rates or land tax, refinancing interest, value-increasing-expenditure interest; the 20 August 1991 acquisition cutoff)
• Income Tax Assessment Act 1997 (Cth), s 110-45 — Assets acquired after 7.30pm on 13 May 1997 — subsection (1B), the “not otherwise deductible” exclusion, quoted directly above
• Income Tax Assessment Act 1997 (Cth), s 108-20 — Losses from personal use assets must be disregarded — subsections (2)–(3), confirming land and buildings are excluded from the “personal use asset” category, quoted directly above
• Income Tax Assessment Act 1997 (Cth), s 118-145 — Absences — the main residence absence rule (6 years if income-producing, indefinite if not), verified against the Act’s own text; see also the site’s existing 6-Year Main Residence Rule explainer
• Holiday Home Tax Deductions: ATO Crackdown from July 2026 — TR 2026/1, the “mainly” test, and the risk-zone framework this article builds on
• BAN TACS Accountants: Capital Gains Tax (CGT) Newsflash Booklet — secondary corroboration of the third-element mechanics, cross-checked against the statute above

Related reading

• 50% CGT Discount Reform: Cost Base Indexation Explained — the core reform mechanics this article builds on
• CGT Reform: What Passed — Final Law From 1 July 2027 — the canonical statement of the enacted Acts, including the element-3 carve-out
• CGT Reform for Property Investors — the general investment-property case for comparison
• Holiday Home Tax Deductions: ATO Crackdown from July 2026 — the “mainly” test and risk-zone framework feeding this article’s Worked Example 2
• The 6-Year Main Residence Rule (and When It Resets) — full mechanics of the absence rule referenced above
• CGT Reform for Deceased Estates and Heirs — for the separate pre-1985 (pre-CGT) reset, relevant to holiday homes bought before 20 September 1985