Did you know that there is a kind of tax that is great to pay? It’s called a capital gains tax and it’s great for one simple reason: you only have to pay it when you make a capital gain! A capital gain means you sold an asset for more than you bought it for. That is always better than the alternative, which is selling an asset for less than you paid yourself.
That said, if you can (legally!) avoid CGT then you should. Last week, we wrote about an idea called rentvesting, which is where a person owns property as an investment but rents the property that they live in. We received a few questions about CGT and rentvesting, so this week we are having a closer look at CGT on residential property.
CGT on the ‘The Family Home’
When it comes to tax, the ‘family home’ is known more formally as either the ‘Main Family Residence’ or the ‘Principal Place of Residence.’ (PPR). As these names suggests, the main feature of the PPR is that you live in it. The great news is that you do not have to pay CGT if and when you sell your PPR. Because it is your home, it is exempt from tax on any uplift in value that occurs while you own it.
In most cases, deciding whether a property is a PPR is quite straightforward. The ATO provide some simple rules about the property. These include:
- That you own the property;
- That the property has a dwelling on it (vacant land cannot be treated as a PPR – even if you sleep under the stars!);
- That you primarily live in that dwelling;
- That you only claim to have one principal place of residence for a given period of time.
That last bullet point is quite important – especially when people spend time living in a property other than their family home. Consider an example where a family owns a city home and a holiday home ‘up the coast.’ Even though they may spend their time 50-50 between the houses, only one house can be treated as the PPR for a particular period of time. When the other property is sold, the capital gain will be taxable.
CGT and Rentvesting
You might be thinking that a rentvestor – who does not live in the property they own – will not therefore qualify for the PPR exemption. Well, if the rentvestor never lives in the property, that will be the case. But, what if the rentvestor does live in the property at least some of the time?
Well, there is an exception that lets people continue to claim a PPR exemption after they move out of a property. There are two forms of this exception. The first is if you do not earn rental income from the property after you move out. In that case, the PPR exemption continues for as long as you own the property. The key is that you do not use the property to generate rental income. It might be that your adult kids live rent-free in the property, or that you use it yourself from time to time (for example, if you retire to the coast but keep the city home for when you need to ‘come to town.’) As long as you do not earn income from the property – and as long as you do not claim some other property as your PPR for the same time period – you will not have to pay CGT.
The second exception is if you do rent the property out once you leave it. In that case, the exemption will only continue for up to six years. Once you have been out of the property for six years, any capital gains that accrue after the 6-year period expires will be subject to capital gains tax.
This second exemption is the one that might suit the rentvestor, because rentvestors usually rent out the property they own. If the rentvestor first uses the property as their main residence, then they will often be able to claim the CGT exemption for up to six years after they vacate the property. So, if a rentvestor owns a property for seven years, having lived in it for the first of those years, they will not pay CGT when they sell. Of course, they cannot also claim that some other property was the PPR, because you can only have one principal place of residence for a given period of time.
A more common scenario might be where the rentvestor moves into their property sometime after they first purchased it. As we discussed last week, a person might own and rent out a property for a few years while they travel or something similar, before moving into a property when they decide to ‘settle down.’
In that case, any rise in the value between the time they first bought the property and the time they first lived in the property will be subject to CGT. Any rise in the value after they move into the property will be CGT-free. It becomes important, then, to accurately value the property at the time that the rentvestor starts living in it.
Do Things Properly
As with everything to do with tax, it is very important that you do things properly and in accordance with the ATO’s various rules. The basic rule of thumb is that you sort out how you are going to manage tax before any money changes hands. This will ensure that you manage things in the most tax-efficient way.
Once again, this is why if you are considering buying a property as a rentvestor, an investor or an owner-occupier, it always pays to talk to us first.