Navigating the tax landscape when selling your home can be challenging. However, understanding the main residence exemption, the impact of earning income on your home while you live in it, and the six-year absence rule can make the process more manageable and allow you to minimise any capital gains tax (CGT) on the sale of the property. In this article, we will cover these topics and provide a case study to illustrate the concepts.
Main Residence Exemption
The main residence exemption allows homeowners to exclude their primary residence from CGT when they sell it. This exemption is crucial for many property owners, as it can result in significant tax savings. For more information about the main residence exemption, you can visit the Australian Taxation Office (ATO) website here.
While the main residence exemption can help you avoid CGT on the sale of your home, it is essential to consider the impact of earning income on your property while you live in it. If you rent out part of your home or use it for business purposes, you may only be eligible for a partial main residence exemption. When a home first becomes income-producing, the property’s market value at that date becomes the first element of its cost base, and the 12 months for eligibility for the 50% CGT discount starts from that date. More details are available on the ATO website here.
Six-Year Absence Rule
The six-year absence rule allows homeowners to continue claiming the main residence exemption on their property for up to six years if they move out and then rent out the property (as an aside, if you move out and do not make the main residence income producing the exemption from CGT is indefinite – not just limited to 6 years). This rule can be particularly beneficial for those who temporarily relocate for work or other reasons and intend to return to their property. For more information about the six-year absence rule, you can visit the ATO website here.
Case Study: Jane’s Property Journey
Let’s consider a case study to illustrate these concepts. Jane purchased a house in 2010 for $800,000 and lived in it for the first year. In 2011, she started renting out one room (25% of the floor space) while continuing to live in the house. At that time, the property was worth $900,000. Jane moved overseas in 2015, and the house was fully let. She returned to the property in 2019 and continued to live there until she sold it in 2022 for $1.5 million.
When Jane first rented out a room in 2011, the market value of the property ($900,000) became the first element of its cost base. Upon her return in 2019, Jane re-established the property as her main residence. As she was away for only four years (from 2015 until 2019), which is less than the six-year absence rule limit, she can still claim the main residence exemption for the entire period of her ownership, subject to the partial exemption for the income-producing portion.
When Jane sold the property in 2022 for $1.5 million, her total capital gain was $600,000 ($1.5 million – $900,000). However, only 25% of the gain that relates to the period where one room was rented out (2011 to 2015) should be taxable. To apportion this taxable gain, we consider the ownership period after it was first income-producing, which is 11 years (from 2011 to 2022). The taxable portion for the four years when one room was rented out is 4/11ths of the total 11-year ownership period after the property became income-producing. Therefore, the taxable capital gain for this period is $54,545 ($600,000 x 0.25 x 4/11).
Since Jane held the property for more than 12 months after it started generating income, she is eligible for the 50% CGT discount. Applying the discount, her taxable capital gain is reduced to $27,272 ($54,545 x 0.5).
In summary, understanding the main residence exemption, the impact of earning income on your home while you live in it, and the six-year absence rule is crucial for homeowners. These tax provisions can interact to significantly affect the amount of CGT you may need to pay when selling your property. Be sure to consult with your client manager at KSW to understand how these rules apply to your specific situation and ensure that you maximize your tax savings when selling your home.
Author – Darren O’Malley
*Correct as of 23 March 2023
*Disclaimer – this article has been produced by Kreston Stanley Williamson as a service to its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas contained in this article, it is imperative you seek specific advice relating to your particular circumstances. Liability limited by a scheme approved under professional standards legislation.