How the "6-Year Rule" can reduce your Capital Gains Tax (CGT)
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Are you planning to sell your property? If so, it's important you understand how Capital Gains Tax (CGT), might apply to the profit from your sale and how it can directly impact your annual income and tax obligations.
When you sell a property and make a profit you may be liable to pay Capital Gains Tax (CGT), however, it's important to be aware of rules and exemptions that might allow you to avoid this tax or reduce it. One of the best-known ways to do this is by using the "6-year rule." This rule can come in handy for property owners, especially those with an investment property who aren't looking to sell for a window of time. If you lived in a property as your Principal Place Of Residence (PPOR) for a period before moving out and renting the property for income, you can still treat that property as your main residence for tax purposes for up to six years. This means you might not have to pay Capital Gains Tax (CGT) if you sell it during this time.
However, the rules can be complex, and while the six-year rule can potentially help you save money, there are other aspects to consider, such as the type of rental income you might earn or how other properties you own can affect your tax situation.
What is Capital Gains Tax?
When you sell a property and make a profit, this profit is called a capital gain. This gain gets added to your other income for the year, and you might have to pay a tax called Capital Gains Tax (CGT) on it. This tax isn't separate; it's part of what you report on your annual income tax return to the Australian Taxation Office (ATO). It's important for property investors to understand this, especially when thinking about selling their Principal Place Of Residence (PPOR) or any other property they own.
What is a Capital Gains Tax event?
When you sell an asset that falls under the Capital Gains Tax (CGT) category, it's termed a CGT event. This is the moment you either earn a capital gain or incur a loss. There are several actions that can activate a CGT event, such as; selling an asset, trading, swapping, or exchanging assets, or when an asset is lost, destroyed, or when the creation of contracts or other rights occurs (referred to as involuntary disposal). The specific CGT event related to your circumstances can influence the exact timing of the CGT event and the method you use to determine your capital gain or loss.
For a clear understanding and to ensure accurate calculations, property investors often benefit from seeking advice from property tax specialists. A property tax specialist can offer insights into how Capital Gains Tax implications might affect your financial situation.
What is the Capital Gains Tax (CGT) six-year rule?
The Australian Taxation Office (ATO) states that when you sell a property used to produce income (such as earning rental income), and you have a profit (or capital gain) from that sale, this profit gets added to your yearly income. It must be reported on your annual income tax return. It's crucial to remember that this Capital Gains Tax (CGT) isn't an extra tax; it's part of your usual income tax.
But there's good news: the ATO offers some tax breaks related to CGT, depending on your situation. For instance, if a property is your main residence (or Primary Place Of Residence), you often don't have to pay CGT when selling it.
How do you prove to ATO that this property is your main residence? Typically, you'd need to:
- Move into the property once the purchase is finalised.
- Store your personal items there.
- Use the property's address for your mail and as your listed address on the electoral roll.
- Connect utilities, like water and electricity, under your name.
Additionally, how long you've lived in the property and your intent to make it your permanent home can also play a role in its classification. For a property to qualify as your main residence, it must have a dwelling (or living structure) on it, and you should have lived there. Simply owning a vacant plot doesn't grant you the main residence exemption.
There's also a beneficial rule called the "six-year rule" for property investors. It lets qualified investors consider their investment property as their main residence for up to six years, allowing them to potentially avoid Capital Gains Tax.
So, if you lived in a property and then rented it out, you could still sell it without facing a Capital Gains Tax liability, provided:
- The property was your main residence before you rented it out.
- You didn't claim any other property as your main residence during that time.
These rules can be complex, so always consider seeking advice from a property tax specialist to ensure you're meeting all the necessary requirements.
Example: the 6-year Capital Gains Tax exemption in action
James acquired an investment property in Sydney, which he designated as his Principal Place Of Residence for the entire four-year period he owned it. This Principal Place Of Residence served as James's home, without any property tax obligations from rental income.
Subsequently, a job opportunity in Melbourne emerged, offering James a two-year tenure. He embraced this opportunity and relocated to Melbourne where he stayed at a relative's place. Throughout this period, James ensured no other property was identified as his main residence. To generate income, he rented out his Sydney property.
At the conclusion of his Melbourne assignment, James elected to permanently reside there, prompting him to put his Sydney property on the market. Using the Australian Taxation Office's six-year rule, he effectively managed to navigate the Capital Gains Tax (CGT) landscape. By understanding the nuances of the main residence exemption and the absence rule, he was able to avoid paying Capital Gains Tax on the sale of his property.
What is the Principal Place of Residence (PPOR)?
The Principal Place of Residence (PPOR) refers to the main place where you live. It could be various types of homes, including: a house, flat, unit, or even unconventional dwellings, such as a caravan or houseboat. Understanding your Principal Place of Residence (PPOR) is important because it can determine your eligibility for certain tax exemptions, such as the main residence exemption, which can affect your Capital Gains Tax.
Determining when your home stops being your main residence
Usually, a property ceases to be your main residence once you move out. However, for Capital Gains Tax purposes, you can opt to consider your previous home as your main residence, even if you're not currently living there.
Several factors determine if a property is no longer your primary residence:
- Neither you nor your family live there anymore
- Your personal items are no longer stored there
- It's no longer the address where you receive your mail
- It's not listed as your address on the electoral roll
- Essential services, like gas and electricity, have been disconnected
The importance of each factor can vary based on your personal situation. How long you've been away from the property and any plans to move back can also play a role in determining the status of the property.
Transitioning to a new primary residence
If you purchase a new residence before selling your previous one, both properties can be considered your main residence for a period of up to 6 months.
This is permissible if all the following conditions are met:
- you occupied your previous home continuously for at least 3 months in the 12 months leading up to its sale, using it as your primary residence
- during that 12-month span, you didn't use your old home to generate income, like rental income, when it wasn't designated as your main residence
- the newly acquired property becomes your primary residence
Other ways to reduce your Capital Gains Tax liability
If an investment property doesn't qualify for full Capital Gains Tax exemptions from the Australian Taxation Office (ATO), property investors can take certain steps to decrease the Capital Gains Tax payable.
One major strategy is to adjust the cost base by adding certain expenses. A capital gain is the difference between the selling price and the cost base.
Costs to reduce capital gains on properties
For property investors, there are various expenses that can be added to reduce the capital gain when selling an investment property.
The following costs can be incorporated:
- incidental costs, such as fees for advertising the rental property, legal services, and stamp duty
- non-deductible ownership costs
- title costs, such as legal costs linked with establishing or defending the property's title
- improvement costs, for instance, when updating the flooring or adding a deck
By including these expenses in the property's cost base, property investors can potentially reduce the Capital Gains Tax (CGT) payable when they sell their investment properties. This means that on their annual income tax return, the assessable income from the capital gain could be lower, reducing their tax liability.
Property investors should consider consulting with property tax specialists to ensure they're understanding Capital Gains Tax implications correctly and making the most of their available exemptions. Proper tax advice might even provide avenues to avoid paying unneccesary Capital Gains Tax (CGT) under specific circumstances, such as the six year absence rule, especially if the property was once a Primary Place of Residence (PPOR).
About Causbrooks
Causbrooks gives you a client manager supported by a team of knowledgeable accountants. We’re here to take the guesswork out of running your own business. Our accountants have much experience working with small business owners.
Get in touch with us to set up a consultation or use the contact form on this page to inquire whether our services are right for you.
Disclaimer
Any advice contained in this document is general advice only and does not take into consideration the reader’s personal circumstances. Any reference to the reader’s actual circumstances is coincidental. To avoid making a decision not appropriate to you, the content should not be relied upon or act as a substitute for receiving financial advice suitable to your circumstances.
FAQ
How the "6-Year Rule" can reduce your Capital Gains Tax (CGT)
Download our Readers Guide to setting up your business
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
Are you planning to sell your property? If so, it's important you understand how Capital Gains Tax (CGT), might apply to the profit from your sale and how it can directly impact your annual income and tax obligations.
When you sell a property and make a profit you may be liable to pay Capital Gains Tax (CGT), however, it's important to be aware of rules and exemptions that might allow you to avoid this tax or reduce it. One of the best-known ways to do this is by using the "6-year rule." This rule can come in handy for property owners, especially those with an investment property who aren't looking to sell for a window of time. If you lived in a property as your Principal Place Of Residence (PPOR) for a period before moving out and renting the property for income, you can still treat that property as your main residence for tax purposes for up to six years. This means you might not have to pay Capital Gains Tax (CGT) if you sell it during this time.
However, the rules can be complex, and while the six-year rule can potentially help you save money, there are other aspects to consider, such as the type of rental income you might earn or how other properties you own can affect your tax situation.
What is Capital Gains Tax?
When you sell a property and make a profit, this profit is called a capital gain. This gain gets added to your other income for the year, and you might have to pay a tax called Capital Gains Tax (CGT) on it. This tax isn't separate; it's part of what you report on your annual income tax return to the Australian Taxation Office (ATO). It's important for property investors to understand this, especially when thinking about selling their Principal Place Of Residence (PPOR) or any other property they own.
What is a Capital Gains Tax event?
When you sell an asset that falls under the Capital Gains Tax (CGT) category, it's termed a CGT event. This is the moment you either earn a capital gain or incur a loss. There are several actions that can activate a CGT event, such as; selling an asset, trading, swapping, or exchanging assets, or when an asset is lost, destroyed, or when the creation of contracts or other rights occurs (referred to as involuntary disposal). The specific CGT event related to your circumstances can influence the exact timing of the CGT event and the method you use to determine your capital gain or loss.
For a clear understanding and to ensure accurate calculations, property investors often benefit from seeking advice from property tax specialists. A property tax specialist can offer insights into how Capital Gains Tax implications might affect your financial situation.
What is the Capital Gains Tax (CGT) six-year rule?
The Australian Taxation Office (ATO) states that when you sell a property used to produce income (such as earning rental income), and you have a profit (or capital gain) from that sale, this profit gets added to your yearly income. It must be reported on your annual income tax return. It's crucial to remember that this Capital Gains Tax (CGT) isn't an extra tax; it's part of your usual income tax.
But there's good news: the ATO offers some tax breaks related to CGT, depending on your situation. For instance, if a property is your main residence (or Primary Place Of Residence), you often don't have to pay CGT when selling it.
How do you prove to ATO that this property is your main residence? Typically, you'd need to:
- Move into the property once the purchase is finalised.
- Store your personal items there.
- Use the property's address for your mail and as your listed address on the electoral roll.
- Connect utilities, like water and electricity, under your name.
Additionally, how long you've lived in the property and your intent to make it your permanent home can also play a role in its classification. For a property to qualify as your main residence, it must have a dwelling (or living structure) on it, and you should have lived there. Simply owning a vacant plot doesn't grant you the main residence exemption.
There's also a beneficial rule called the "six-year rule" for property investors. It lets qualified investors consider their investment property as their main residence for up to six years, allowing them to potentially avoid Capital Gains Tax.
So, if you lived in a property and then rented it out, you could still sell it without facing a Capital Gains Tax liability, provided:
- The property was your main residence before you rented it out.
- You didn't claim any other property as your main residence during that time.
These rules can be complex, so always consider seeking advice from a property tax specialist to ensure you're meeting all the necessary requirements.
Example: the 6-year Capital Gains Tax exemption in action
James acquired an investment property in Sydney, which he designated as his Principal Place Of Residence for the entire four-year period he owned it. This Principal Place Of Residence served as James's home, without any property tax obligations from rental income.
Subsequently, a job opportunity in Melbourne emerged, offering James a two-year tenure. He embraced this opportunity and relocated to Melbourne where he stayed at a relative's place. Throughout this period, James ensured no other property was identified as his main residence. To generate income, he rented out his Sydney property.
At the conclusion of his Melbourne assignment, James elected to permanently reside there, prompting him to put his Sydney property on the market. Using the Australian Taxation Office's six-year rule, he effectively managed to navigate the Capital Gains Tax (CGT) landscape. By understanding the nuances of the main residence exemption and the absence rule, he was able to avoid paying Capital Gains Tax on the sale of his property.
What is the Principal Place of Residence (PPOR)?
The Principal Place of Residence (PPOR) refers to the main place where you live. It could be various types of homes, including: a house, flat, unit, or even unconventional dwellings, such as a caravan or houseboat. Understanding your Principal Place of Residence (PPOR) is important because it can determine your eligibility for certain tax exemptions, such as the main residence exemption, which can affect your Capital Gains Tax.
Determining when your home stops being your main residence
Usually, a property ceases to be your main residence once you move out. However, for Capital Gains Tax purposes, you can opt to consider your previous home as your main residence, even if you're not currently living there.
Several factors determine if a property is no longer your primary residence:
- Neither you nor your family live there anymore
- Your personal items are no longer stored there
- It's no longer the address where you receive your mail
- It's not listed as your address on the electoral roll
- Essential services, like gas and electricity, have been disconnected
The importance of each factor can vary based on your personal situation. How long you've been away from the property and any plans to move back can also play a role in determining the status of the property.
Transitioning to a new primary residence
If you purchase a new residence before selling your previous one, both properties can be considered your main residence for a period of up to 6 months.
This is permissible if all the following conditions are met:
- you occupied your previous home continuously for at least 3 months in the 12 months leading up to its sale, using it as your primary residence
- during that 12-month span, you didn't use your old home to generate income, like rental income, when it wasn't designated as your main residence
- the newly acquired property becomes your primary residence
Other ways to reduce your Capital Gains Tax liability
If an investment property doesn't qualify for full Capital Gains Tax exemptions from the Australian Taxation Office (ATO), property investors can take certain steps to decrease the Capital Gains Tax payable.
One major strategy is to adjust the cost base by adding certain expenses. A capital gain is the difference between the selling price and the cost base.
Costs to reduce capital gains on properties
For property investors, there are various expenses that can be added to reduce the capital gain when selling an investment property.
The following costs can be incorporated:
- incidental costs, such as fees for advertising the rental property, legal services, and stamp duty
- non-deductible ownership costs
- title costs, such as legal costs linked with establishing or defending the property's title
- improvement costs, for instance, when updating the flooring or adding a deck
By including these expenses in the property's cost base, property investors can potentially reduce the Capital Gains Tax (CGT) payable when they sell their investment properties. This means that on their annual income tax return, the assessable income from the capital gain could be lower, reducing their tax liability.
Property investors should consider consulting with property tax specialists to ensure they're understanding Capital Gains Tax implications correctly and making the most of their available exemptions. Proper tax advice might even provide avenues to avoid paying unneccesary Capital Gains Tax (CGT) under specific circumstances, such as the six year absence rule, especially if the property was once a Primary Place of Residence (PPOR).
About Causbrooks
Causbrooks gives you a client manager supported by a team of knowledgeable accountants. We’re here to take the guesswork out of running your own business. Our accountants have much experience working with small business owners.
Get in touch with us to set up a consultation or use the contact form on this page to inquire whether our services are right for you.
Disclaimer
Any advice contained in this document is general advice only and does not take into consideration the reader’s personal circumstances. Any reference to the reader’s actual circumstances is coincidental. To avoid making a decision not appropriate to you, the content should not be relied upon or act as a substitute for receiving financial advice suitable to your circumstances.
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This category can cover various topics related to taxation, such as changes in tax laws, how to file taxes, common tax mistakes, and tax planning strategies.
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