Capital Gains Tax
Capital gains are the profits you earn by selling assets. Moreover, since your property is treated as an asset, you need to pay tax on the profits obtained from this sale. Therefore, when you sell or dispose of rental property, you may incur capital gains or losses. Capital gains or losses are the difference between the cost (cost basis) of acquiring and improving the property, and the amount you receive when you dispose of the property.
Capital Gains Tax Exemptions or Discounts
There are several ways to avoid capital gains tax. These exemptions include:
- If your property is your main residence: Your main residence (your home) is usually exempt from capital gains tax (CGT). This is known as the "main residence exemption".
- Capital gains tax property investment 6-year rule: Six-month rule- ATO allows you to hold two main residences if you buy a new house before the buyer disposes of the old house. In this case, both properties will be regarded as main residences for up to six months
- If you hold your investment property for 12 months or more before selling the property, you can enjoy a 50% CGT discount
What is the main residence?
Generally speaking, a dwelling is considered your main residence if:
- You live in it with your family
- Your personal belongings are in it
- This is your mail delivery address
- This is your address on the electoral roll
- Services such as natural gas and electricity are connected
Qualifications
You can claim the main residence exemption if you are an Australian resident and the dwelling:
- has been the home of you, your partner and other family members throughout the period you have it
- has not used to generate income - that is, you don't use it to run a business, rent or "flip" it (buy it to renovate and sell it for profit)
- is on 2 hectares or less.
But if you do not meet all these conditions, you may still be entitled to a partial exemption. You can use the CGT property exemption tool to calculate the exemption ratio.
The 6-year Rule of Capital Gains Tax on Property Investment
The capital gains tax property 6-year rule allows you to use your property investment for up to six years, just like your main residence, and you rent it. This means that you will be able to sell the property within six years and will be exempt from capital gains tax as if you were selling a house where you mainly live.
Meanwhile, if you do not use it to earn money, you can hold onto the property indefinitely without paying a tax on your profits. This could be the case if you decide to hold onto it as a holiday home.
It all revolves around treating your home as your main residence, even after you move out. When you buy a property, you can choose to treat it as your main residence or investment. If you do not live in the property for at least 12 months after purchasing the property, you may not consider it the main residence. However, after you have lived in the property for 12 months, you can move out of the house and rent it for up to 6 years, and apply for capital gains tax exemption from your annual income and the income from the sale of the property as long as you sell it within 6 years.
The six-year capital gains tax property rule will attract homeowners who want to earn additional income during the period that they are not able to reside in the dwelling - all of which will not lead to the payment of capital gains tax on the final sale.
When Do You Pay Capital Gains Tax on property investment?
Capital gains tax is paid when a CGT event occurs such as the time when the property is sold. It is important to understand which fiscal year occurred in order to take advantage of the basic tax results. For those who cause capital losses, this amount can be carried forward to offset future capital gains, but cannot be used to reduce taxable income. Of course, you need to pay attention to some conditions when using the six-year rule of capital gains tax property:
- First, unless the six-month rule is applied, you will not be able to treat another property as your main residence for the same period
- Second, for the rules to apply, you must first consider your main residence before renting. Immediately using it as investment property will disqualify you from the capital gains tax property 6-year rule
Reducing Capital Gains Tax Payable
If you did not know about the six-year rule of CGT on property investment when you first purchased a property, you may not treat your property as your main residence. In this situation, you can choose to take advantage of CGT discounts. One way to reduce CGT when selling an investment property is if you hold the property in your own name for more than one year. This will entitle you to a 50% discount on capital gains tax payable on the sale of the property.
If you decide not to sell your main residence after six years of rental, the "market value rule" will apply to help potentially reduce your capital gains. This means that when you finally decide to sell the property, the market value of the house will be taken into account when you first decide to rent. In this case, you will be eligible for a partial exemption, which means that the full exemption will be reduced from the time the property is no longer considered your main residence.
Chang Accounting Advisory Pty Ltd, we are CPA practice, we could help clients to tax planning of capital gain tax on property investment. If you or your families or friends need our services, please feel free to contact our team for any assistance.
This article is for informational purposes only and does not form part of our advice. This article is based on ATO information. Please contact our team if you need any assistance.
Claire Chang, 0497 131 419, claire.chang@changadvisory.com.au, wechat: clairechang26
Michelle Cui, 0433 539 870, michelle.cui@changadvisory.com.au, wechat: michellejc
Claire Chang