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CGT IMPLICATIONS OF TURNING AN INVESTMENT PROPERTY INTO A TEMPORARY PPOR
Question: My partner and I purchased an investment property in November 2012 for $550k. It has been rented out for the entire time since settlement, but we are thinking about moving in for six months (then re-letting it) as we have heard that, if you live in it for the first 12 months of ownership, you are exempt from capital gains tax later on, once you have moved out and re-let the property. Can you please advise on this, as we won’t bother moving back in for a six-month period if it doesn’t exempt us from CGT. The question is how does CGT work? Thank you very much for your advice. It is very much appreciated!
Answer: On first being purchased, a property can be established as either a main residence (MR) or a rental investment (RI). The nature of first usage of the property will dictate how the capital gain is calculated on sale at a profit.
Whenever a property is occupied as an MR, it will be exempt from capital gains tax (CGT) for that period of time. When a property is occupied by a tenant on first being acquired, some tax may apply if a capital gain is realised when it is sold.
When a property is owned for longer than 12 months, then only 50% of the capital gain is taxable. A taxable capital gain is included on your tax return as normal income. When it is added to your income this may push you into a higher marginal tax rate.
For tax to be payable in the first place, there has to be a sale at a price that is higher than the cost base. In its simplest form, a capital gain is basically calculated as the difference between the net selling price and the cost base.
When a property is first established as an RI and then changes to being occupied as an MR, its cost base will include the original purchase price, stamp duty, legal fees, building inspection fees, etc. The taxable portion of the capital gain will then be apportioned on the basis of time (number of days) occupied as a rental and time occupied as an MR.
Take the example of a five-year ownership period with four years of occupation as an MR. Assuming the capital gain is calculated at $100k, the portion to be declared is only $100/5=$20k. As the property has been held for longer than 12 months, a discount of 50% is available, making the amount to be shown on a tax return $10k.
What the question above refers to is the ‘six-year rule’. This is relevant only when the property is established as an MR when first purchased. If at a later time (say six to 12 months later) it is rented out, there will be no CGT to be paid if the property is sold within the next six years. Note, however, that as you are only allowed one MR that is exempt, you cannot nominate another property you own as your MR during this period of time.
CGT WHEN SELLING AT A LOSS
Question: We own a rental property that has unfortunately lost value since we owned it, and we are considering selling it (actually need to sell it). If we sell it for less than we paid for it, is this a tax deduction?
This particular type of loss is known as a capital loss, and specific rules apply to this loss. These types of losses may only be offset against capital gains (these may arise from the profit made from the sale of other assets such as shares or properties, to name a few).
Depending on your particular circumstances, there may be an immediate deduction available to you if you have made a capital gain in the financial year that you sell the property. However, if you have not realised a capital gain or enough gain to offset the loss against, you will be able to carry forward this capital loss to be used in future income years.
CGT WHEN TURNING A PPOR INTO AN IP PERMANENTLY
Answer:There is some good news regarding your capital gains situation.
The main residence exemption may apply in your case. This exemption will allow you to treat your existing home as your main residence, for capital gains purposes, for a period of up to six years while you are leasing it. It must be noted, however, that you cannot nominate any other dwelling as your main residence during this period. If you were to lease the property beyond six years, then proration would have to be considered.
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