Many Australians enter the property market with the expectation that property prices will rise. This means that you make a healthy amount of money, which is great – until capital gains tax comes into play.
Capital gains tax (CGT) is the contribution of the profit you’ve made to the Australian Taxation Office (ATO). Unfortunately, tax is inevitable – but there are ways to get around it in certain instances. Knowing how to qualify for an exemption from capital gains tax can save you thousands of dollars.
One way to avoid paying capital gains tax is by following the capital gains tax property 6-year rule – and here’s everything you need to know.
When Do You Pay Capital Gains Tax on Investment Property?
A capital gain refers to making a profit when you sell a property; that is, if you sell the property at a higher price than what you bought it for. Conversely, the opposite is known as a capital loss.
Any capital gains need to be declared on your annual income tax return.
The tax induced by capital gains must be paid and accounted for when the capital gains tax event occurs. This typically occurs when the property gets sold. The financial year the capital gains tax event occurs in is important to note to benefit from the base tax outcome.
If you’ve made a capital loss, the amount can be carried forward to offset any capital gains in future years. It can’t be used as a way to minimise assessable income from other sources, though.
How Can You Be Exempt From the Capital Gains Tax Payable?
If you live in the property, it is called your principal place of residence (PPOR). Typically the sale of a principal place of residence with a capital gain qualifies it for a main residence exemption.
For a property to be your primary place of residence, you must:
The capital gains tax property 6-year rule is a method to qualify a former home into an investment property as an owner-occupier so you can receive main residence exemption when you make capital gains.
How Can You Qualify For a Tax Exemption With an Investment Property?
Property investors must follow the three golden rules regarding the sale of investment properties when making a capital gain if they want to avoid triggering capital gains tax liabilities:
- Upon purchasing the property, it must immediately be used as your principal place of residence. If you rent it out straight away to use as an investment property, you will be disqualified from the six-year rule of main residence exemption and you’ll still have to pay CGT.
- If you need to move out of your property and still want to claim main residence exemption, you are only allowed to make another property your primary place of residence for a six month period. To qualify, you need to meet at least one of the following requirements:
• your property was your primary place of residence for a continuous period of at least three months during the twelve months before you sold the property,
• your property wasn’t rented out to receive assessable income during the twelve months before selling, or
• the new property will be your new official main residence.
- If you move out of your property and rent it out but don’t stay in the investment property as your primary place of residence, you can still qualify for a capital gains tax exemption for up to six years under the six-year absence rule. The Australian Taxation Office states that this could be applicable if:
• you accept a new job interstate or overseas,
• you have to move in to look after a sick relative, or
• you go on an extended holiday.
What If You Are Away From Your Principal Place of Residence More Than Once?
Each period of time that you don’t stay in your property as your principal place of residence is seen by the Australian Taxation Office as its own individual instance.
This means the capital gains tax property 6-year rule effectively resets every time you move back into your property, so you can avoid paying capital gains tax on the condition that you move back within up to six years of moving out.
As it stands, there isn’t a limit on the number of times you can make use of these tax exemptions.
And, if you move out of your primary place of residence for a period of more than six years and don’t rent out the property, you can still claim main residence exemption from capital gain tax.
When you sell your home or investment property and make a profit, you will be subject to capital gain tax.
This can amount to having to pay tax for thousands of dollars, so many people use the six-year rule to avoid capital gains tax. The three golden rules are:
Currently, there isn’t a limit on the number of times you can make use of the six-year rule to avoid capital gain tax.
Understanding capital gains tax and how to avoid it as tax liability isn’t easy. Contact us today to connect with a property tax specialist.
The property tax specialists at KNS Accountants can give you strategic advice to help you save money and reach your financial goals.
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 contractors and small businesses. 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 your own advice for any legal or tax issues raised in your business affairs.