Property. It’s an asset that most of us will acquire in our lifetime, an asset which can be used in vastly different ways. Property can be your main residence, your primary place of business, commercial and investment tenant arrangements, AirBNB, foreign property investments, and many other uses.
How property is used can significantly impact the current and future tax consequences of the property.
In this article, we will briefly touch on the following topics:
- Main residence exemption
- Partial main residence exemption
- 6-year main residence absence rule (including cost base uplift in value)
What is the Main Residence Exemption?
The main residence exemption is a valuable tax break that prevents homeowners from paying Capital Gains Tax (CGT) on the sale of their home. In order to receive the main residence exemption there are certain conditions that need to be met to be eligible for this exemption:
- The property must be the owner’s main residence for the entire period they have owned it. This means that the homeowner must have lived in the property and treated it as their primary residence.
- The property must not have been used for income-producing purposes during the time the owner has owned it. This means that the property must not have been rented out, and no part of it should have been used for business purposes.
- The land is less than 2 hectares.
If these conditions are met, the homeowner can claim the main residence exemption and avoid paying CGT on the sale of their property.
When does the Partial Main Residence Exemption apply?
There may be some scenarios when a property begins as your home but then stops being your main residence (e.g. it becomes an investment property).
If a homeowner decides to rent out their main residence or use it for income producing purposes (for example, operating a business from the home), it is possible that the main residence exemption will be lost for the period that the property is used to generate income. This means that when they sell the property, they may be liable to pay CGT on the proportion of the property’s value that is attributed to the time it was used to generate income.
For example, if a homeowner owned a property for ten years and lived in it for eight of those years before renting it out for two years, they would only be entitled to the main residence exemption for eight years. They would be liable to pay CGT on the proportion of the property’s value that relates to the two years it was rented out subject to the application of the 6 year main residence rule referenced below.
Foreign residents for tax purposes are not eligible for the main residence exemption. This means that if they sell a property that they own in Australia, they may be subject to CGT on any profit they make, even if it was their main residence whilst they were tax residents of Australia.
It is important to note when a property changes from your main residence to an investment property, the tax cost base of the property is uplifted to the market value of the property at the date the property became an investment property.
For example, let’s say you were to purchase a property for $250,000 and live in this property for 10 years. After the 10 year period, you decide to turn the property into a rental property. The market value of the property at the date the property became an investment was $850,000. For taxation purposes, the cost base of the property will be uplifted to the market value of the property at the date the property became an investment, which in this case is $850,000. Any future Capital Gains on the sale of the property will be determined by the sale price less the uplifted cost base of $850,000.
What is the 6 Year Main Residence Absence Rule?
Usually, a property stops being your main residence when you stop living in it. However, for CGT purposes you can continue treating a property as your main residence:
- for up to 6 years if it’s used to produce income, such as rent (sometimes called the ‘6-year rule’); or
- indefinitely if it is not used to produce income.
During the time that you treat the property as your main residence after you stop living in in, it continues to be exempt from CGT (the same as if you were still living in it, even if you start renting it out after you leave). Additionally, you can’t treat any other property as your main residence (except for up to 6 months if you are moving house).
If you use your former home to produce income (business or rental) for more than 6 years in one absence, it is subject to CGT for the period after the 6-year limit.
If you don’t use your former home to produce income (for example, you leave it vacant or use it as a holiday house) you can continue to treat it as your main residence for an unlimited period after you stop living in it. This only applies if you aren’t treating another property at the same time as your main residence.
If a home owner is a foreign resident who sells their Australian home, they will generally not be entitled to the main residence exemption under the absence rule.
Consideration and effective use of the 6 year main residence absence rule can minimise any capital gains tax implications where you do not acquire a replacement main residence.
Contact Us for Support
There are many factors that should be considered when using property assets. How you use or don’t use your property asset will determine the tax consequences of the property.
We are taxation property experts who can point you in the right direction and ensure you understand the various tax consequences associated with your property assets.
This article was written by Michael Rebula, a Tax and Business Services Manager. Michael can provide you with expert advice in relation to the taxation consequences of different used property assets. To make an appointment or speak to Michael, please call our office on 5261 2029 or email Michael at email@example.com.
Disclaimer: this information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Davidsons accepts no responsibility for any loss suffered as a result of any party using or relying on this article.