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 from capital gains tax (CGT), which occurs when you sell your property.
The good news is that there are several 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.
What is 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.
It is worth noting that capital gains tax is not a separate tax and is included in your annual income tax return.
How to define your 'main residence'
Your main residence, or principal place of residence (PPOR), is the property you live in full time. If you buy a property to rent out as an investment, this is considered a rental investment property.
How the ATO defines your principal place of residence (PPOR)
The Australian Taxation Office (ATO) exemptions consider that your property is your main residence. That’s why it’s important to understand what it actually means for a property to be your main residence, and how you achieve this.
The ATO considers several factors 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 principal 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 individually to make a qualified decision.
Determining when your home stops being your main residence
When you stop satisfying most of the main residence criteria mentioned above, a property is no longer considered your main residence. Typically this will happen the day you move out for an extended period of time.
Does the 6-year CGT exemption apply to your main residence?
The six-year exemption rule applies to your main residence and reduces the CGT you pay upon selling it.
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, your CGT will also increase.
Does the 6-year CGT rule apply to investment properties?
Yes. The ATO’s six-year CGT exemption rule applies to investment and rental properties. We will discuss the intricacies of this further down.
What is the 6-year capital gains tax exemption?
A common question surrounding CGT on property investment is around when a property’s main residence status 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 CGT exemption rule comes into play.
Once your property no longer meets the ATO’s main residence criteria, you can still claim it as your principal place of residence for up to six years. This is known as the six-year absence rule or six-year exemption.
The CGT exemption period can vary depending on how you utilise the property after you leave:
- If you’re renting it out, it can remain your main residence for up to six years.
- If you don’t rent the property, it can remain considered your main residence indefinitely.
The six-year CGT exemption for the main residence is counted on a daily basis; if you get to six years minus one day and stop renting the property out, you can continue to own and treat it as your principal residence indefinitely.
Further, there’s no hard limit on the number of times you can access this exemption. See an example of how this works in practice below.
Example: the 6-year capital gains tax exemption in action
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 to be a good starting point. And the longer you live on your property, the better.
Can you have two primary residences in Australia?
Yes, you can, but 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.
Does the ATO 6-year rule apply to two main residences?
While you may functionally have two principal residences, you can only designate one as your principal place of residence for CGT purposes.
For example, say you've lived in one property and then moved into a second property for an extended 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 lodged 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.
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Can foreign residents benefit from the 6-year CGT rule?
Recent rulings from the government 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 to sell your home but are likely to become a foreign resident in the near future, you should consider the CGT implications.
6 facts about the 6-year primary residence exemption rule
- When claiming a six-year principal 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 allow 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 — you’re likely to receive only a partial exemption.
- Another thing to be aware of is that the main residence exemption is only available for land with property. You can’t claim the principal 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.
The final word: how to apply for the 6-year CGT exemption
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 Liston Newton tax accountant.
Capital gains tax exemptions in Australia
The six-year exemption isn’t the only way to minimise your main residence CGT obligations. Here are a few more tips and tricks that you might like to read up on:
- Remember the date of purchase - properties acquired before 20 September 1985 are exempt from CGT.
- Purchase properties using your super fund - if you have a self-managed superfund and have owned your property for at least 12 months, you can claim a CGT discount if you’re still in your super accumulation phase. If you’re retired and claiming your pension, you won’t have to pay CGT at all.
- Increase your asset cost base - the cost base is the amount you pay to purchase, own, improve and sell your property: the higher your cost base, the lower your CGT obligations.
