How to avoid capital gains tax when selling property
When you sell an asset you typically must pay capital gains tax (CGT) on any profit which you make on the sale.
For most of us, the most valuable asset we own is our family home and many of us stand to make a large profit if we sell.
So does that mean that you have to pay CGT when you sell your house?
Fortunately, in most cases, the answer is no. The tax law provides an automatic exemption for any capital gain (or loss) which arises when a taxpayer sells their main residence.
However, this isn't a blanket exemption. There remain situations where some or all of the gain arising on disposal of your main residence may be liable for CGT.
Tip: The main residence exemption is only available to individuals and not to a company. Usually, it is not available to trustees though it may be available to the trustee of a deceased estate. Bear this in mind when buying a house, particularly if you choose to purchase through a corporate or trust structure.
What is my main residence?
In short, it's your home.
The ATO has set out some of the factors which it looks for in determining whether the property you have disposed of is your main residence. These include:
- Whether you and your family live there;
- Whether you have moved your personal belongings into the home;
- Whether your mail is delivered to the property;
- Whether the residence is your address on the electoral roll
- Whether you have services and utilities connected (for example, phone, gas, or electricity);
- Whether you intend the dwelling to be your main residence.
There is no minimum time that you have to live in a home before it can be considered to be your main residence, although a period of greater than three months is often taken as the benchmark. Even if you only own a house for a short period - six months, say - provided you tick all the boxes above, the property will be your main residence.
To obtain the full exemption, it isn't enough to simply own the house; it must also qualify as your main residence throughout the period of ownership. This period begins at settlement of the purchase contract and ends at settlement of the sale contract. If you only live in the house for part of the period of ownership, you will only get a partial exemption.
Simply intending to occupy the dwelling - without actually doing so - is not good enough to trigger the exemption.
The main residence exemption can only apply to a property that includes a dwelling, i.e. anything that is used wholly or mainly for residential accommodation.
Examples of a dwelling are:
- a house or cottage;
- an apartment or flat;
- a strata title unit;
- a unit in a retirement village;
- a caravan, houseboat or other mobile home.
Simply owning land isn't enough to claim the exemption, even if you intend to build a dwelling at a later date.
However, you can choose to treat land as your main residence for up to four years before a dwelling is constructed in certain circumstances. You can choose to have this exemption apply if you acquire land and you:
- build a dwelling on the land
- repair or renovate an existing dwelling on the land, or
- finish a partly constructed dwelling on the land.
There are a number of conditions that you must satisfy before you can claim the exemption. You must first finish building, repairing or renovating the dwelling and then:
- move into the dwelling as soon as practicable after it is finished
- continue to live in the dwelling as your main residence after it becomes your main residence, ideally for at least three months.
And what about the land surrounding the house?
The CGT exemption includes any land adjacent to or surrounding the house, to the extent that that land is used for private or domestic purposes in association with the dwelling. What that means is that a garden is fine but an agricultural field is not.
To qualify, the land, together with the land on which the house sits, should not exceed two hectares in area. Anything over two hectares would not be covered by the exemption and a gain (or loss) would arise on the surplus part. The taxpayer can choose which two hectares to include but it must include the land on which the house is situated.
The land need only be close to or near to the land to qualify as adjacent. So, even if the land was across the road from the house, it would still be adjacent.
The exemption also covers a garage, store room or any other structure that is attached to or forms part of the house provided it is used primarily for primary for domestic purposes. For example, if you run a business from the garage, the exemption would not apply to the garage but if you simply park your car there, it would apply.
If adjacent land (or a garage, store room, etc) is sold separately from the rest of the property, the CGT exemption will not be available in relation to that disposal unless the land has been compulsorily acquired.
Moving into the house
The main residence exemption also covers any period from when the dwelling is acquired to the time it is first practicable to move in. This takes account of situations where, for example, there is a delay in moving in because of illness or some other reasonable cause.
The exemption does not extend to cases where you can't move into the dwelling because it's being rented out or because it would simply be "inconvenient to move in", for example, because you were employed elsewhere or because you were seconded to a new employment before moving in.
However, it would cover a period after a tenancy ends if the owner could not move in immediately because repairs need to be done to the property to make it habitable again.
This rule means the exemption will only be partially available if the house is not moved into from the time it is first practicable to do so.
Can I have more than one main residence?
You can only ever have one main residence at any given point in time. The exception is if you're selling your old property and buying another. In this case, you're entitled to an overlap period of six months when both properties can be your main residence as long as:
- the new property will be your main residence after the sale of the old property;
- you lived in the old property for at least three continuous months in the 12 months prior to sale; and
- the property wasn't used to generate rental income in any part of the 12-month period that it wasn't your main residence.
If that six-month period is exceeded, you can claim the main residence exemption for the 6 month period up to the disposal of the old house but a partial exemption will apply to whichever house did not qualify as the main residence beyond the six-month date.
Can I earn income from my main residence?
Increasingly, people are using their home to produce income. Sometimes they do that by renting out part or all of the property, sometimes they do it by running a business from home. In the last few years in particular there has been a boom in the number of home-based businesses.
If you tick one of those boxes, you may be forsaking part of your CGT exemption.
This is because you cannot usually obtain the full main residence exemption if you used any part of your home to produce income during all or part of the period you owned it.
Tip: People who simply work from home as part of their job (such as teachers who might do some marking in the evening or anyone else who might do a bit of overtime away from the office) are not affected.
If you use your home to produce income, you are generally only entitled to a partial main residence exemption.
Special rule for first income-producing use
The above rules are further complicated by an additional rule that applies where you have lived in the property for some time without generating income from the property and then commence an income-earning activity.
In that case, you are taken to have acquired the dwelling at the first time it was used to produce income for its market value at that time. This effectively wipes out the tax history of the property up until the time you started your income earning activity.
Tip: If you start to earn income from your property for the first time, you will need to get a market valuation for the property on the date you commence your income earning activity. It makes sense to get a market valuation done at that date by a qualified valuer.
Renting out the whole property - the "six year absence" rule
In some situations, it is possible to continue to enjoy a full main residence exemption event though you are totally absent from the property and are earning income from it, possibly through renting it out.
If you own a property which is currently your main residence you can move out of the property for up to six years and still get the full exemption provided no other property becomes your main residence during the absence.
During that time you can earn rental income on the property and claim a tax deduction (via tax professional life H&R Block) for expenditure as you would with a normal investment property. It isn't necessary to move back into the property before the disposal for the six-year absence rule to apply.
Note that the "six year rule" resets each time you move back into the property and live in it as your main residence. That means that if you move back in and then later move out again, renting the property to tenants, you get a further six-year absence period during which the main residence exemption is protected. In theory, that cycle can continue indefinitely until the property is finally disposed of.
The six-year concession can only apply if the house has actually already qualified as your main residence.
Tip: If you purchase another property whilst absent, you only need to make the choice as to which property to treat as the main residence on disposal of the first dwelling, not at the time of the absence. This gives you an opportunity to plan and to pick the property with the better tax outcome.
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