Michael Quinn explains little known ways to avoid CGT when turning your home into a rental.
One downfall to renting out an investment property is the capital gains tax (CGT) that will be payable upon the sale of the property. CGT is the tax charged on capital gains that are procured from an asset. You are liable to pay this tax when your capital gains exceed your capital losses in an income year.
However, there are legal ways to avoid paying CGT while renting out your house. Capital gains tax exemptions are allowed by the Australian Taxation Office (ATO) under certain scenarios. People’s lives are constantly changing. Whether it’s due to a change of future plans or circumstances, there are many reasons why you may decide to lease out your main place of residence. In order to do this without incurring CGT, be sure to understand the ATO’s rulings with regards to this topic.
The following simple rules apply:
- Only your main place of dwelling will be exempt from CGT. Thus you can’t own two properties, live in one for a couple of years and then alternate between that property and your main residence while avoiding paying CGT on both houses.
- Usually, if you purchased a house after 7.30pm on 20 August 1996 you have to have lived in it when it was first bought (ie, not rented it out) to be entitled to a full exemption. This is because by renting the property straight away, the ATO deems you to have acquired the property purely as an investment to produce income.
- Provided the above terms are met, you are exempt from CGT if you rent out your home for less than six years.
- If you’ve held a property for more than 12 months and the ATO has deemed you subject to CGT, you are entitled to a 50% discount.
- Capital gains tax is dependant on individual circumstances and as such claims can become quite complex. This is especially true where you own multiple properties and increase the frequency with which you move from one property to another.
Exceptions to the rule
Below is a summary of the criteria for full and partial exemptions:
Full exemptions
To qualify for a full CGT exemption, the property must have been your main residence from when you acquired it. If you move out of the property and rent it out, you can continue to claim an exemption from CGT for up to six years after you move out. If you do not rent it out, you can claim a CGT exemption for the property for an indefinite period after you move out.
Moving from your main residence could be for reasons such as:
· Accepting a new job interstate or overseas
· Staying with a sick relative long term
- Going on an extended holiday
A taxpayer can still apply the six year exemption rule if they acquire and reside in another property. However, there is no ‘Main Residence’ exemption applied to the second property which subsequently becomes subject to capital gains tax.
Partial exemptions
In situations where multiple investment properties are acquired over the period, the ATO sees the six years as cumulative. This denotes that you only get six rental years in total before you are liable to pay CGT. Fortunately, the CGT will be exacted proportionately, for instance if you made a $200,000 capital gain on a property that you rented out for eight years, you will only have to pay CGT for the two-year period that exceeds the six-year exemption. Thus, the CGT will be exacted on $50,000, then take into account the 50% discount for holding a property for over 12 months and this gets dropped down to $25,000. You will be able to verify whether or not this exemption applies to you via the ATO website, or through a CGT knowledgeable accountant.
Partial main residential exemption after 1996
If you originally bought the house with the intent to rent it out after 20 August 1996, but later changed your mind and chose to live there, you will become partially exempt from CGT on a proportionate basis of ‘years lived in’ to ‘years rented’.
When there is a change of status from income producing to main residence or vice versa, you should obtain a valuation as of that date. A real estate agent’s valuation should suffice; however, a valuation from a licensed valuer is recommended.
Below are some general yet useful guidelines:
- Although there are provisions for farmers, properties larger than two hectares are not exempt from CGT.
- The residences of private companies and trusts (etc) do not qualify for a CGT exemption.
- If you use part of your house in order to generate income, for example, a home business, then CGT will be exacted on that section if you claim tax deductions such as interest rates, insurance or rent.
- If you have purchased a new property but are still in the process of selling the old one, you need to complete the sale within three months in order to avoid paying CGT.
When it comes to deceased estates, presuming the house was the sole residence of the deceased, a full exemption exists providing the property is sold within two years of the deceased’s passing.
Capital gains tax can be a very intricate topic. Therefore, advice must be sought for individual circumstances.
