Property investors can save thousands of dollars by simply understanding the capital gains tax property six-year rule.
A capital gains tax event occurs when you sell your property, triggering the need to calculate and potentially pay CGT.
Additionally, you can save money by understanding the consequences of capital gains tax (CGT) before you rent out an investment property.
Here’s some insight into the steps that will guarantee you’re not liable for any CGT when you decide to sell your property.
What is Capital Gains Tax? (CGT)
The Australian Taxation Office explains that 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 gain; or if you lost money, a capital loss.
To calculate capital gains tax, or CGT, you need to determine the capital proceeds cost base, and apply any discount or indexation factors to arrive at the final taxable capital gain. Any profit on the sale of real estate assets 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?
Calculating Capital Gains Tax
Calculating capital gains tax (CGT) can be a complex process, but understanding it is essential to minimise your tax liability. To start, you need to determine the capital proceeds, which is the amount you receive from selling your investment property. This includes the sale price and any additional amounts, such as rent or interest.
Next, you need to establish the cost base. The cost base is the amount you initially paid for the property plus any additional costs incurred. These costs can include stamp duty, solicitor fees, and conveyancing fees. Don’t forget to add any capital improvements, such as renovations or extensions, as these can significantly increase your cost base.
Once you have the capital proceeds and cost base, you can calculate your capital gain or loss. If the capital proceeds exceed the cost base, you have a capital gain. Conversely, if the capital proceeds are less than the cost base, you have a capital loss.
To reduce your CGT liability, you can apply any eligible discounts or indexation factors. For instance, if you have held the property for more than 12 months, you may qualify for a 50% discount on your CGT. This means only half of your capital gain will be subject to tax, making a significant difference in your taxable income.
Capital Gains Tax Rates and Payment
Australia’s capital gains tax rate isn’t fixed; it varies based on your individual tax situation and the tax bracket you fall into. For individuals, the CGT rate aligns with their marginal tax rate. For example, if you fall into the 32.5% tax bracket, your CGT rate will also be 32.5%.
For companies, the CGT rate is a flat rate of 26% for trading companies with an annual turnover of less than $50 million and 30% for those exceeding $50 million. Self-managed super funds (SMSFs) enjoy a lower tax rate of 15%, making them an attractive option for property investment.
When it comes to paying capital gains tax, you will need to pay on your net capital gain, which is the profit made from selling an asset after deducting the costs. It’s also possible to offset future capital gains against capital losses, but you cannot offset capital losses against future capital gains. This means careful planning and record-keeping are essential to optimise your tax outcomes.
Capital Gains Tax Exemptions or Discounts
You can avoid capital gains tax in Australia in several ways.
The first one is the main residence exemption. Main residence exemption allows homeowners to avoid paying capital gains tax if their property is their principal place of residence (PPOR).
One common way to reduce your CGT liability is by using the CGT discount method, which can significantly lower the taxable amount if certain conditions are met.
Other exemptions include:
- The capital gains tax property six-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 is when the ATO allows you to hold two PPORs if a new home is acquired before a purchaser disposes of the old one. In this case, both properties will be treated as PPOR for up to six months.
What is a Principal Place of Residence (PPOR)?
Before delving into the capital gains tax property six-year rule, it’s important to understand what constitutes a principal place of residence.
As a general rule, main residence exemption dismisses capital gains tax payable on the sale of the property you regard as your family home, which is your principal residence. This is because you don’t generate an income from living in your own home; therefore, the property sale is exempt from CGT.
There are a few guidelines that need to be met for your home to be considered your main residence or PPOR. These include, but are not limited to:
- it’s the main residence where you and your family have resided for the full duration that you have owned it;
- it’s the main residence where your belongings are;
- it’s the main address used to receive your postal mail
- it’s the main address on your driver’s licence and the electoral roll; and
- it’s the main residence where all the connected utilities are in your name.
According to the ATO, the preferred proof is the address where your utility bills are sent, which is generally sent every three months.
For investors who do not necessarily plan on residing in their property investment, it is worthwhile knowing about the capital gains tax property six-year rule before renting it out straight away!
What is the CGT Six-Year Rule?
The six-year capital gains tax property rule allows you to use your property investment as if it were your principal residence in Australia for up to six years whilst you rent it out.
This means that you could sell the property within six years and be eligible for a capital gains tax exemption, just as you would if you sold the house, which is considered your main residence or PPOR.
The six-year absence rule exists because there are many reasons why you may not be living in your property for some time. The Australian Tax Office recognises that there are various unique circumstances beyond the property owner’s control.
The capital gains tax property six-year absence 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 CGT 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 official main residence for the entire period that he has owned it.
Since then, he has been offered a two-year work placement in Perth. He accepted the placement and moved to Perth, opting to live with his cousin. As a result, he does not treat any other home as his main residence. In the meantime, he has decided to rent out his own residence 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. By applying the capital gains tax property six-year rule, he was able to sell the property and claim the CGT exemption.
Thanks to the six-year absence rule, he was not required to pay tax for capital gains.
When Do You Pay Capital Gains Tax on Investment Property?
Capital gains tax is paid when a CGT event occurs, such as selling the property. You can use the CGT discount method to calculate capital gains tax liability, which may reduce the taxable amount. Capital gains tax may also apply to inherited property, but there are exemption conditions that could affect this liability.
It’s important to understand which financial year this occurs in 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 using the capital gains tax property six-year rule:
- First, you will not be able to consider another property your main residence for the same period unless you apply the rule.
- Secondly, for the rule to be applicable, it must be considered your main residence before being rented out. Immediately using it as an investment property will disqualify you from the capital gains tax property six-year rule.
What If You Are Away From Your PPOR More Than Once?
Rent out is handled as an individual case for each period you do not reside in your PPOR. This means the capital gains tax property six-year rule restarts each time you move back into the home.
Each period of absence has its own capital gains tax implications, which must be carefully considered to optimise your tax outcomes.
Provided that each interim period that you are away is at most the six years, then you can avoid paying the capital gains tax.
Currently, there is no fixed constraint on how many times you can use this exemption.
Example:
Jessica owns a house in Sydney and lived in it as her main residence between 2013 and 2016. However, she has 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 make it her main residence once more while she freelanced. Not long after, she managed to get another permanent job, this time in Brisbane.
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.
What If You Didn’t Treat Your Property as Your Main Residence?
If you didn’t know about the six-year rule for capital gains tax property, your next best option is to take advantage of CGT discounts.
One way to reduce your CGT liability 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.
To calculate the net capital gain when selling an investment property, you can use methods such as the discount method and the indexation method. The net capital gain is determined by subtracting the cost base from the sale price, and then applying any eligible discounts or adjustments.
If you decide not to sell the PPOR residence after six years of renting it out, the ‘market value rule’ will apply to help potentially reduce your capital gains.
This means that when you eventually decide to sell the property, the home’s market value will be considered when you first decide 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.
It’s essential that investors maximise their return and reduce the capital gain tax on their investment properties when they decide to sell, especially when they have undergone some form of renovation.
For every capital gains tax event that occurs on their investment property, they will need to calculate their capital gain or capital loss.
For many, this can be a daunting task. That’s when a Capital Gains Tax Report comes in handy.
The 12-Month Ownership Main Residence Exemption
If you’ve owned your investment property for at least 12 months before selling it, you may be eligible for a 50% CGT discount. The capital gains tax rate you will pay depends on your individual tax situation and the duration of property ownership. If your capital gain is $100,000, you must only declare $50,000 as taxable income under this partial exemption.
Sold your property and shocked by the CGT?
Reducing Capital Gains Tax
Suppose the circumstances surrounding an investment property don’t meet the criteria for the full concessions and exemptions offered by the Australian Taxation Office. In that case, there are a few ways in which property investors can reduce the amount of capital gains they have to pay.
One of the most significant ways an investor can reduce their capital gains tax is by increasing their cost base with allowable expenses.
Net capital gains are the profits from the sale of an asset after deducting the cost base and any applicable discounts. The tax on net capital gains varies for different entities such as individuals, companies, and self-managed superannuation funds, and is calculated based on the entity type and the duration of asset ownership.
According to the ATO, when you sell your property, the difference between how much you paid for it and how much you sold it is known as capital gains.
So, a capital gain = selling price – cost base.
The cost base = purchase price + expenses (see below) – (grants + depreciation).
Expenses That Can be Added to the Cost Base
The expenses that investors can add to a cost base include, but are not limited to:
- Incidental costs include your rental advertisement fees, legal fees and stamp duty.
- Ownership costs such as those incurred when searching and inspecting for properties.
- Title costs include the legal fees incurred when organising and defending the title on the property.
- Improvement costs should you decide to replace the flooring or install a deck, for example.
Including these expenses in your cost base can significantly impact your capital gains tax calculation, potentially reducing your CGT liability.
By adding expenses to the property’s cost base, investors can reduce the capital gains they declare on their annual income tax return.
This could lead to a reduction in the amount of CGT required to pay on the sale of the investment property.
Avoiding CGT When Selling an SMSF Investment Property
Purchasing an investment property through a self-managed super fund (SMSF) provides several tax benefits:
- The SMSF pays a lower 15% tax rate on rental income, dropping to 10% for properties owned over 12 months
One of the key capital gains tax benefits of using an SMSF is the lower tax rate on rental income and potential CGT exemptions during the pension phase.
- When the SMSF is in the pension phase, no CGT is payable if the property is sold.
Capital Gains Improvement Report
The best way to determine what expenses investors can add to their cost base and how they can reduce the amount of capital gains they declare would be to have a quantity surveyor draw up a Capital Gains Improvement Report.
A Capital Gains Improvement Report essentially helps streamline the reduction process by factoring in all capital expenses for a property, providing a comprehensive capital gains tax report.
Detailing these expenses will give investors an accurate picture of the cost base of the property’s total value, which will ultimately help reduce the amount of CGT payable.
The scenario below shows the benefit of a capital gain improvement report prepared by Duo Tax Quantity Surveyors and the ramifications of not including the capital improvements.
Example: Sale of a Rental Property with a Capital Gain Improvement Report
| Example 1. Cost Base Unindexed: | |
| Purchase price of the property | $550,000 |
| Pest and building inspections, stamp duty, and solicitors fees on the purchase | $50,000 |
| Capital improvements (calculated by Duo Tax Quantity Surveyors) | $150,746 |
| Real estate agent fees and solicitors fees on the sale | $18,500 |
| Total cost base unindexed | $769,246 |
| b. Capital Gain Calculation: | |
| Proceeds from the sale of the property | $850,000 |
| Less cost base unindexed (as calculated above) | ($769,246) |
| Total current year capital gains | $80,754 |
In this example, the property investor included the capital improvements cost, calculated by a property tax specialist (Duo Tax), to increase their cost base and decrease their capital gain.
| Example 2: Sale of a Rental Property without a Capital Gain Improvement Report | |
| a. Cost Base Unindexed: | |
| Purchase price of the property | $550,000 |
| Pest and building inspections, stamp duty, and solicitors fees on the purchase | $50,000 |
| Real estate agent fees and solicitors fees on the sale | $18,500 |
| Total cost base unindexed | $618,500 |
| b. Capital Gain Calculation: | |
| Proceeds from the sale of the property | $850,000 |
| Less cost base unindexed (as calculated above) | ($618,500) |
| Total current year capital gains | $231,500 |
By comparing the two examples, we can see that the client saved a total of $150,746 in capital gain tax by including the capital improvements captured in their report.
The “Years Lived In vs. Years Rented” Partial Exemption
When a property transitions from investment to your primary residence, you can claim a partial capital gains tax exemption proportional to the number of years it was your main residence vs rented out.
For example, if you owned a property for 10 years and it was your primary residence for 8 of those years, then only 2/10ths of the capital gain would be subject to CGT when you sell.
Frequently Asked Questions
Q: What is capital gains tax?
A: Capital gains tax (CGT) is a tax on the profit made from selling an asset, such as a property.
Q: How do I calculate capital gains tax?
A: To calculate CGT, you need to determine the capital proceeds, cost base, and apply any discount or indexation factors.
Q: What is the capital gains tax rate?
A: The CGT rate in Australia is not a fixed rate but is paid through the marginal rate of tax if needed.
Q: Can I offset future capital gains against capital losses?
A: Yes, you can offset future capital gains against capital losses, but you cannot offset capital losses against future capital gains.
Q: What is the main residence exemption?
A: The main residence exemption allows homeowners to avoid paying CGT if their property is their principal place of residence (PPOR).
Seeking Professional Help
Navigating the complexities of capital gains tax can be challenging, which is why seeking professional help is highly recommended. A qualified tax agent or accountant can guide you through the intricacies of CGT, ensuring you take full advantage of all available exemptions and concessions. They can also assist in preparing your tax return, ensuring compliance with all tax obligations.
Additionally, a quantity surveyor can prepare a Capital Gains Improvement Report for you. This report will help identify all the capital expenses you can claim, ultimately reducing your CGT liability. By seeking professional help, you can ensure that you are minimizing your tax liability and maximizing your returns, making the most of your property investment.
Key Takeaways
If you are selling a property, you should know that any profit made from the sale is potentially considered a capital gain and, therefore, subject to capital gains tax.
For personalized capital gains tax advice, it is recommended to consult with a qualified tax professional who can guide you through the complexities of CGT.
Suppose investors aren’t able to avoid capital gains tax. In that case, they can substantially reduce the amount of CGT they pay by having one of our quantity surveyors draw up a Capital Gains Improvement Report for their property.
It’s also worthwhile noting that tax assessments are not set in stone; the ATO allows an amendment period of two years from the notice of assessment.
This means that if you have already lodged your tax and didn’t include capital improvements, you could still benefit from the Capital Gains Improvement Report for two years after you lodged your return.
Here’s a handy table that maps out ways to avoid CGT on your property:
| Strategy | Description | Key Points |
| Main Residence Exemption | Selling your principal place of residence (PPOR) is exempt from CGT. | – Property must meet PPOR criteria (e.g., main address, utility bills, driver’s licence).- Exemption applies for the duration it was your main residence. |
| CGT 6-Year Rule | Allows temporary renting of PPOR for up to 6 years while still claiming main residence exemption. | – Each 6-year absence period is treated individually.- No limit on number of times you can use this exemption.- Property must have been your main residence before renting out. |
| 12-Month Ownership Discount | If you’ve owned your investment property for 12+ months before selling, you may get a 50% CGT discount. | – Only applies to properties owned by individuals, not companies or trusts.- Discount applies to net capital gain (sale price minus cost base). |
| Increasing Cost Base | Adding eligible expenses to your cost base reduces the capital gain and thus CGT payable. | – Expenses can include purchase costs, ownership costs, improvement costs, and sale costs.- A Capital Gains Improvement Report from a quantity surveyor can help calculate this. |
| SMSF Investment Property | Buying an investment property through a self-managed super fund (SMSF) provides tax benefits. | – SMSF pays lower 15% tax on rental income (10% if owned 12+ months).- No CGT payable if sold during pension phase. |
| Partial Main Residence Exemption | Claim a partial exemption for the proportion of time the property was your main residence vs. rented out. | Example: If owned for 10 years and was PPOR for 8, then only 2/10 of capital gain is taxable. |
To get the best possible advice on your CGT options, and inquire about our Capital Gains Report, get in touch with our property tax specialists today.
See also:
- Capital Gains Tax Property Valuation: Why Every Investor Needs One
Missed out on the CGT 6 year rule?
Order our Capital Improvements Report to help you lower your CGT bill!
Tuan is an award winning Quantity Surveyor and leads Duo Tax Quantity Surveyors – Australia’s fastest growing provider of Tax Depreciation.
