Investment property can be a lucrative way to set your family up for a future nest egg. However, if you’re looking to maximise the value of your property investments, you need to be aware of the costs that come along with it.
The biggest cost you’re likely to face comes in the form of Capital Gains Tax (CGT), which occurs when you sell your property.
The good news is that there are a number of exemptions available for CGT which reduce the amount of tax you’re required to pay. In this article we look at the six-year exemption rule on CGT, and what this means for your investments.
Contact Liston Newton Advisory today to discuss how we can help you minimise your tax, and maximise the value of your assets and property.
Understanding Capital Gains Tax
A capital gain refers to the profit you make on the sale of an asset. And, because your property is considered an asset, you’re required to pay tax on the profit you make from this sale. This is your Capital Gains Tax.
You're eligible for the six-year exemption if your property is considered your 'main residence'.
How to define your 'main residence'
If you live in your property full time, then this is considered your main property. If you buy the property to rent out as an investment, this is considered a rental investment property.
Whichever category your property falls into, you may still be required to pay CGT when it comes time to sell. And if your property has increased in value, this means your CGT will increase too.
However, the good news is that the Australian Taxation Office (ATO) has put a number of exemptions in place to alleviate the amount of CGT you’re required to pay when selling property.
The majority of these exemptions take into consideration that your property is your main residence. So, it’s important to understand what it actually means for a property to be your main residence, and how you achieve this.
The ATO takes several factors into account during their review of your property, and there’s no single criterion that is the determining factor.
The ATO will typically determine that a property is your main residence when:
- You and your family live there, and you keep your personal possessions there
- This is your main residential mailing address
- You’re enrolled on the electoral bill at this address
- Your property has all the usual utilities connected, in your name
If you only satisfy some of these criteria then the ATO will need to review your situation on an individual basis in order to make a qualified decision.
Things to keep in mind
- When claiming a main residence exemption on your CGT, you can only do this under your individual name. Properties that are held within trust or company structures aren’t able to access this exemption.
- As an individual, you can only have one main residence at a time. The exception to this rule is when you’re moving house. In this instance, certain provisions are in place that allows you to have two main places of residence. However, this is only available for a six-month period.
- If you use your main residence to derive income, you might be disqualified from claiming the exemption, or may only be eligible for a partial exemption. So if you rent out your property, or run a business directly from the premises, you may not qualify for the exemption.
- Operating from a home office is different, as you’re not actively running a business or deriving income from your home. In this case, you can still claim the exemption. But as soon as you use your property as business premises—such as a workshop, garage, or salon—then you’re likely to only receive a partial exemption.
- Another thing to be aware of is that the main residence exemption is only available for land that actually has property on it. You can’t claim a main residence exemption on a vacant block.
- ‘Main residence’ only accounts for up to 2.5 hectares of land. If your property is greater than 2.5 hectares, then you can only receive an exemption on your home and the surrounding 2.5 hectares.
What is the six-year exemption?
A common question surrounding CGT on property investment is around when a main residence starts and finishes. When you stop living in your house, then sell it at a later date, how does this get treated? This is where the six-year exemption rule comes into play.
Once your property is no longer considered your main place of residence — that is, it doesn’t satisfy the criteria outlined above — then for CGT purposes, it’s no longer considered your main residence.
However, the ATO does allow some leeway on this. Even after you move out, for CGT purposes you’re allowed to treat your property as your main residence for up to a six-year period. This is known as the six-year absence rule, or six-year exemption.
This time can vary depending on what happens after you leave the premises:
- If you’re renting it out, it can remain considered as your main residence for up to six years.
- If you don’t rent the property, it can remain considered as your main residence indefinitely.
There’s no hard limit on the number of times you can access this exemption, either.
You buy a property in 2005 and live in it for four years. In 2009, you get a new job interstate, so you move out of your home and rent it out.
You rent the property until 2013, but then you return to Victoria and move back into your original home. You stay here until 2016 when you see another job appear interstate. You’re allowed to move out again, and access another six-year absence period.
Throughout this entire time, your property has been classified as your main residence for CGT purposes, so you’re completely exempt from paying CGT on its sale.
In this second time away, your property would be considered your main residence up until 2022, or until you buy a new property that’s considered your main residence during this time.
It’s best to get a thorough market valuation of your property at the close of this six-year period. This provides you with an accurate price and clear documentation outlining the capital gain you’ll make during the time your property isn’t your main residence.
When you move back into your property, the ATO doesn’t have a clear answer as to when it technically becomes your main residence again. However, common sense would consider a period of six months or more be a good starting point. And the longer you live in your property, the better.
Determining when your home stops being your main residence
When you stop satisfying the majority of the main residence criteria mentioned above, this property is no longer considered as your main residence. Typically this will happen the day you move out for an extended period of time.
How to decide whether or not your home is your main residence
Things can get complicated when you own more than one property. This gets even more complicated when you live in more than one property for an extended period of time.
For example, say you've lived in one property then move into a second property for an extended period of time. Under the six-year absence rule, both properties could technically be considered your main residence for the first six years after you move out of the first property. This leaves you with the dilemma of determining which property is considered your main residence for CGT purposes when you sell either property.
You don’t actually need to make this decision until you’ve sold your property and lodge your tax return. In this case, you have the chance to determine the capital gain on both properties, and decide which one will have the most benefit of being considered your main residence.
Your accountant can help you determine which property will have the most tax-effective benefits.
Advice for foreign residents
There have been recent rulings from the government that affect the ability of foreign residents to claim this exemption.
Under this new ruling, from 1 July 2020, if you’re classed as a foreign resident, any sale will be fully taxable, even if it’s technically classed as your main residence during this time.
So, if you’re looking at selling your home, but you’re likely to become a foreign resident in the near future, you should consider the CGT implications.
The final word
Navigating CGT can be confusing at the best of times, so it’s crucial to understand when exemptions of any kind come into play.
To make sure you’re set to qualify, and therefore minimise your CGT as much as possible, get in touch with your accountant.