Recently I was talking with a friend who told me he had sold his property because of capital gains tax concerns. I immediately frowned upon his decision, had he had the conversation with me earlier he could still be earning rent and enjoying more capital growth from his property. He had heard of the 6-year CGT rule from a friend and worried that because his 6 year theshold is near it's end, he would have to pay capital gains tax on all his gains.
The misconception
You can rent out your main residence for up to six years with out incurring capital gains tax. However, if you sell after 6 years, you are liable for capital gains.
The above statement, though correct is misunderstood. Let me run through an example of a common misconception:
Date | Event |
2000 | John buys his main residence for $500,000. |
2001 | John moves to live with his girlfriend and rents out his property. |
2008 | John sells his property for 1,000,000. |
In the above example, a common misconception is to think you are liable for a capital gains tax bill of $250,000 to be added to your taxable income. Though not entirely untrue, it does not have to end up like this.
The right thing to do
Date | Event |
2000 | John buys his main residence for $500,000. |
2001 | John moves to live with his girlfriend and rents out his property. |
2007 | John arranged for property valuation to be done. The property was valued at $850,000. |
2008 | John sells his property for 1,000,000. |
The ATO* states that you are allowed to use your main residence to produce income for up to 6 years immediately after you cease living in it as long as you do not treat another property as your main residence. In 2007, if John wishes to keep the property, he has a couple of options:
- Move back into the property (for a minimum of up to 6 months for the main residency rule to "reset" for another 6 years)
- Get a property valuation done
If moving back into the property is not an option, John should consider getting a professional property appraisal done. When he sells the property in 2008, he will only be liable for the capital gains after the 6 year mark. In additional to the capital gains concession for holding the property for more than 1 year, he will be liable for a capital tax bill of $150,000 * 50% = $75,000 to be added to his taxable income.
* https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Real-estate/Treating-a-dwelling-as-your-main-residence-after-you-move-out/