Knowing the capital gains tax property 6 year rule saves property investors thousands of dollars.

Yet first-year investors are often caught off-guard by this.

Being aware of the capital gains tax (CGT) consequences before renting out an investment property could save you more than a pretty penny.

This article will arm you with the knowledge and appropriate steps to take to guarantee that you’re not liable for any CGT at the time of selling your property.

So, What is Capital Gains Tax?

According to the Australian Tax Office (ATO), when you sell your property, the difference between how much you paid for it and how much you sold it for is known as a capital gains; or if you lost money, a capital loss.

Any profit on the sale of your asset is considered a capital gain and needs to be declared on your annual income tax return.

But how can you ensure your property is exempt from capital gains tax?

Capital Gains Tax Exemptions or Discounts

There are several ways in which you can avoid the capital gains tax. These exemptions include:

  • If your property is your principal place of residence (PPOR)
  • The capital gains tax property 6 year rule – see below
  • The 50% CGT discount if you’ve held your property for 12 months or more before the CGT event, i.e. selling the property
  • The six-month rule – this when the ATO allows you to hold two PPOR if a new home is acquired before a purchaser disposes of the old one. Both properties will be treated as PPOR for up to six months in this case

What is a Principal Place of Residence (PPOR)?

Before understanding the capital gains tax property 6 year rule, it’s important to understand what constitutes as a principal place of residence.

As a general rule, you are exempt from paying capital gains tax on the sale of the property you regard as your family home, which is known as your principal place of residence.

This is because you don’t generate an income from living in your own home.

There are a few criteria that need to be met for your home to be considered your PPOR. These include, but are not limited to:

  • living in your family home for the full duration that you have owned it;
  • keeping your possessions there;
  • using the address to receive your postal mail; and
  • having all the connected utilities are in your name.

For property investors who do not necessarily plan on residing in their investment, it is worthwhile knowing about the capital gains tax property 6 year rule before renting it out straight away!

What is the Capital Gains Tax Property 6 Year Rule?

The capital gains tax property 6 year rule allows you to use your property investment, as if it was your principal place of residence, for a period of up to six years, whilst you rent it out.

This means that you would be able to sell the property, within the six-year period, and be exempt from paying capital gains tax just as you would if you sold the house you primarily resided in.

As there are many reasons why you may not be living in your property for some time, the ATO recognises that there are various unique circumstances beyond the control of the property owner.

The capital gains tax property 6 year rule will also appeal to homeowners wanting to make some additional money for the period that they are not able to reside in their home — all without prompting the need to pay capital gains tax upon its eventual sale.

Example:

Michael purchased a house in Brisbane and has lived in it for the past four years. It has been his main residence for the entire period that he has owned it.

Since then, he has been offered work placement in Perth for a two-year duration. He accepted the placement and moved to Perth and opted to live with his cousin. As a result, he did not treat any other home as his main residence. In the meantime, he has decided to rent out his home while he is away, to bring in some extra revenue.

After two years, he decided to move to Perth and sell his home in Brisbane permanently. Through the application of the capital gains tax property 6 year rule, he was able to sell the property and claim the CGT exemption.

Consequently, he was not required to pay capital gains tax.

When Do You Pay Capital Gains Tax on Investment Property?

Capital gains tax is paid when a CGT event occurs. This refers to when the property is sold.

What’s important to understand is which financial year this occurs to take advantage of the base tax outcome. For those making capital losses, the amount can be carried forward to offset future capital gains but cannot be used to reduce assessable income.

There are, of course, conditions that you need to be aware of that come with the using the capital gains tax property 6 year rule:

  1. First off, you will not be able to consider another property as your PPOR for the same period unless applying the six-month rule
  2. Secondly, for the rule to be applicable, it must be first considered your PPOR before being rented out. Immediately using it as an investment property will disqualify you from the capital gains tax property 6 year rule

In the interest of avoiding capitals gains tax, you’ll need to live in the property for a minimum of six months for it to be considered your PPOR before moving out and using it as an investment property.

After that period, you can move out of the property and rent it out for up to six years. Or you could choose not to rent it out and rather treat it as a holiday home.

Either way, you will still be able to claim a capital gains tax exemption.

What If You Are Away From Your PPOR More Than Once?

Each period that you do not reside in your PPOR and rent out is handled as an individual case.

This means that the capital gains tax property 6 year rule restarts each time you move back into the home.

Provided that each interim period that you are away does not surpass the six years, then you can avoid paying the capital gains tax.

Currently, there is no fixed constraint on the number of times you can make use of this exemption.

Example:

Jessica owns a house in Sydney and has lived in it as her PPOR between 2013 and 2016. She has, however, since been employed at a new company in Melbourne. As a result, she decided to move and rent her property out.

In 2019 she decided to move back to her home in Sydney and freelance for a while. Not long after, she managed to get another permanent job in Brisbane this time.

According to the capital gains tax property 6 year rule, she can move interstate again and access another absence period up to six years.

In 2020, Jessica decided to sell her property in Sydney so that she can permanently reside in Brisbane. She qualified for the main residence exemption and was not required to pay capital gain tax.

You Didn’t Treat Your Property as Your PPOR When You First Purchased It. How Do You Reduce Your Capital Gains Tax Payable?

If you didn’t know about the capital gains tax property 6 year rule, your next best options are to take advantage of CGT discounts.

One way to reduce your CGT when selling your investment property is if you hold the property in your name for more than one year. This will entitle you to a 50% discount on your capital gains tax payable when you sell the property.

If you make the decision not to sell the PPOR residence after six years of renting it out, the ‘market value rule’ will be applicable to help potentially reduce your capital gains.

This means that when you eventually decide to sell the property, the market value of the home will be considered at the time you first decided to rent it out.

In this case, you will qualify for a partial exemption, which means that the full exemption will be reduced commencing from the period when the property was no longer considered your main residence.

Key Takeaways

The capital gains tax property 6 year rule is best applied before the purchase of your investment property.

Many property investors had made the mistake of not treating their property as a PPOR before renting it out and have subsequently missed out on being exempt from CGT when they decided to sell.

So, if you want to reduce paying capital gains tax on your investment, you should consider living in the property for the first six months before using it to generate an income.

To avoid paying capital gains tax entirely, then make sure that the property remains your PPOR. Then sell it within six years so that you can apply the capital gains tax property 6 year rule and qualify for the main residence exemption.

Beyond avoiding paying capital gains tax, property investors should also be aware of the benefits of claiming tax depreciation to minimise their tax burden each financial year. Duo Tax are the property tax depreciation experts and by purchasing one of our tax depreciation schedules, our customers have saved thousands of dollars in tax each year. Get in touch with us to find out how you can also save.

Disclaimer: Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek a second professional opinion for any legal or tax issues raised in your investing affairs.
Portrait of Tuan Duong

Tuan Duong is an award winning Quantity Surveyor and leads Duo Tax Quantity Surveyors – Australia’s fastest growing provider of Tax Depreciation. Reach out to him directly on 0431 154 356 or email tuan@duotax.com.au

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