Selling A Rental Property… Let’s Talk Capital Gains Tax
Written by: Canny Accounting
So, you’ve decided to sell your rental property, but you used to live in it? A big myth is this would be tax-free as it was your home, however, unfortunately, the reality is a lot more complex, so we’re going to give you the information you need so you can make an informed decision on where you stand when it comes to selling a rental property that was your home!
Let’s Talk Tax Law + The Main Residence Exemption
The main residence is usually exempt from tax when making a capital gain or selling the home.
Owner-occupiers typically don’t produce assessable income from their main residences, so the ATO exempts them from paying capital gains tax on the sale of their home.
However, for your property to be considered your main residence or your primary place of residence (PPOR), you will have to show the Australian Tax Office, among other things, that:
- You’ve lived in your main residence for the entire duration that you’ve owned it;
- You keep your possessions at your main residence;
- You use the property’s address to receive your post;
- The property’s connected utilities are in your name; and
- You are registered on the electoral roll covering that address.
Now you may be wondering how this benefits you as a property investor and not an owner-occupier. Well, it’s worthwhile knowing about the main residence capital gains tax six-year rule because it could qualify you for the main residence exemption.
The Six-Year Rule + Your Financial Plan
The capital gains tax six-year rule allows property investors to treat their investment property as if it was their main residence for a period of six years to qualify for their main residence exemption.
So, just like an owner-occupier would sell their main residence without triggering capital gains tax liability, you, as a property investor, can do the same, provided that:
- Your investment property was initially considered your main residence before it was used to produce assessable income; and
- You don’t nominate another property as your main residence for the same time period.
After establishing the property as your main residence, it is possible to move out and rent the property out for up to six years.
The most common way people claim the main residence six-year exemption is when they cannot reside in their home for some time, for example, due to work relocation or obligations out of state. Instead of leaving it empty, most people opt to generate an investment income from it.
Not only will you be generating an income while you are aware, but you can also use the main residence exemption in the event that you sell the property and make a capital gain. It could end up being a win-win situation for many property investors.
Another beneficial element of claiming the main residence exemption using the six-year rule is that it resets each time the property is re-established as the main residence when you move back in. In other words, each time you move back home, the six-year rule resets. So you can claim the main residence exemption, provided that you don’t move away for more than six years at a time.
There are also two additional capital gain exemptions you can claim, including:
- A partial capital gains tax exemption should you have held your investment property for 12 months or more before selling it; and
- The six-month rule, allows you to keep two main residences or primary place of residence for six months in a situation where you buy your new home before selling the old one.
Moving Into Your Rental Property + How Much Is Taxed on Capital Gains
If you rented out your investment property from day one, then you will not qualify for the six-year rule. However, you will qualify for a partial capital gains tax exemption for the period that the property was your main residence.
For example, if you rented out a property for five years, then moved in and treated the property as your main residence for five years, then 50% of the capital gain would be exempt due to the main residence exemption.
General Capital Gains Tax Discount
As with any asset, if your rental property is owned for 12 months or more before selling, it qualifies for the 50% general capital gains tax discount.
Financial Reporting on CGT + Airbnb
A capital gain from the sale of your main residence is usually exempt from capital gains tax (CGT). However, if you use your main residence to earn income, for example, by renting out a room on a sharing economy platform, you will no longer be eligible for the full capital gains tax exemption on that main residence. You will lose a portion of your main residence exemption based on the floor area rented out, and the length of time it was rented.
Reporting Capital Gains Tax On Your Income Tax Returns
When lodging an income tax return, taxpayers are required to report the disposal of their property, even if they are exempt from capital gains tax due to the main residence exemption. Failure to include the disposal of your property may attract the Australian Tax Office’s attention.
Including rental income, in previous years’ income tax returns or advertising your property on Airbnb indicates to the ATO that the property has been used to produce assessable income and may also attract an ATO Audit. Worried about an ATO Audit? Check out this blog that we put together on how Not to Be A Fool and Get Caught Out With An ATO Audit.
Help From The Accountants Geelong Trust for Investment Advice
While capital gains tax is an inevitable part of your investment journey, the ATO does allow you to claim certain exemptions.
So when you decide to sell your investment property, knowing about these capital gains tax exemptions could end up saving you substantial amounts of money in the long run.
Get in touch with our expert team who are the accountants Geelong turns to for trusted advice when it comes to your investment property. Regardless of where you are on your journey when it comes to investment properties, we can guide you through the process from start to finish with holistic advice.
