Property Gains Tax and Understanding the 6 year rule
The biggest deterrent for most people is the thought of paying capital gains tax, which occurs when you sell your property.
Note that there are a number of exemptions available for CGT which reduces the amount of tax you’re required to pay. Let’s take a closer look at the 6 year rule.
Understand 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 all the time, then this is considered your main property. If you buy the property and rent it out this is considered a rental investment property. Whatever way your property falls, you may still be required to pay CGT when it comes time to sell. Remember if the value of the property goes up then so does the Capital Gain. Not to worry the Australian Taxation Office (ATO) has a number of exemptions in place to lessen 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. It’s important to understand what it means for a property to be your main residence, and what boxes we need to tick. 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. Remember:
· 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.
· Individuals 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 home 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.
· Note 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.
What is the six-year exemption?
A common question we need to get our heads around is the 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 and it doesn’t satisfy the criteria — then for CGT purposes, it’s no longer considered your main residence. However, the ATO does allow some flexibility 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.
Example:
If you buy a property in 2004 and live in it for four years. In 2008, you get a new job interstate, so you move out of your home and rent it out. You rent the property until 2014, but then you return to Victoria and move back into your original home. You stay here until 2017 when you find another job interstate. You’re allowed to move out again, and access another six-year absence period. During the course of this time, your property has been classified as your main residence for CGT purposes, so you’re completely exempt from paying CGT on its sale. Regarding the 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 would be prudent 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, a good point to start from would be a period of six months or more.
Determining when your home stops being your main residence
When you stop satisfying the main residence criteria mentioned above, clearly 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, it gets even more complicated when you live in more than one property for an extended period of time.I f 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 deciding which property is considered your main residence for CGT purposes when you sell either property.
You don’t need to make this decision until you’ve sold your property and lodge your tax return, this then gives you an opportunity work out which property to nominate as your permeant place of residence. If you have any further questions don’t hesitate to contact me.
Laz Kiriakidis