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Most of you will know that a gain made on the sale of a Principle Place of Residence is exempt from capital gains tax. However the waters are muddied if you have rented the property for a certain period of time, or if has been used to produce an income. In this article I will explain how the process works under various scenarios.
As noted above, a full exemption known as the Main Residence Exemption can be made if the dwelling was your main residence throughout ownership and was not used to generate income. But how do the ATO determine what a “Main Residence” is?
There is actually no specific ATO definition for it, likewise despite popular belief there is actually no duration of time you need to stay in a property to make it your main residence. In theory it could be a day.
However the ATO treat every case individually and they will consider how long you have lived there, as they will consider whether your family are there, whether your belongings are there, where your mail is going to, are you paying the bills, your address on the electoral role.
The Six Year Absence Rule!
Many of you more savvy readers will already be aware of this. There is a ruling that allows you to still use the main residence exemption even if you have been renting your Principle Place of Residence for up to six years.
However be careful! The ATO is able to consider your INTENTIONS for why you rented the property and did not live in it for the time in question. There would need to be at least some reasoning, such as that you changed work locations and the dwelling in question was therefore further from work. If your only reason for renting our your PPR and renting somewhere else yourself was to avoid tax, then this is considered TAX EVASION. If you were to rent out your apartment and then rent the one next door yourself, the ATO would not look too kindly on this at all!
In theory you can be absent from the property for more than six years if the period is broken up by you moving back in for some reason.
EXAMPLE 1: John lives in a house for 2 years before heading off to PNG to work for four years. He returns and lives in the property again for 2 years, before being posted out again for 3 years. When he returns he sells his house. John would be able to claim the exemption for both periods of absence (total 7 years) because the individual periods of absence were both less than 6 years.
Again, however there should be valid reasons, such as John’s reasons above. You cannot move back in to the property for say, 3 months after each 6-year period, just for the purpose of avoiding tax.
Special Ruling for Building or Repairing a Property!
Generally speaking vacant land cannot be treated as a main residence as it is deemed that you cannot reside on it. However, there is a special ruling that allows you to treat land as a PPR for up to four years, as long as you are either building on it or repairing/renovating it, and as long as you move in as soon as is practicable.
So what happens if you EXCEED six years when renting a property? Fortunately, you should be able to claim a Partial Exemption for the six-year period.
EXAMPLE 2: John purchases a property on January 1st 2000 for $400,000, and lives in it for two years until 1st January 2002, at which time it is worth $450,000. He then rents it for 7 years until 1st January 2009 at which time he sells for $590,000. The capital gain since it was rented has been $140,000. However the taxable capital gain would be calculated by dividing 365 days (period rented after 6 years has lapsed) by 2,555 days (entire period of time property was rented) multiplied by the capital gain of $140,000 = $20,000. I.e. he receives a (substantial) partial exemption of $120,000 for the six year period.
- Members of a couple cannot EACH own a Principle Place of Residence. Even in the extreme case that they both have 100% ownership of each property and reside in the different properties, they are still expected to either nominate one property to be the Principle Place of Residence for both of them, OR, they can nominate both properties as their PPR and claim a PARTIAL exemption on each.
- There can be Capital Gains Tax implications if you subdivide land. Even if you eventually sell all lots in one go to the same buyer, you can generally only claim the PPR exemption for one parcel of land. Be vigilant in speaking with your accountant if you are considering subdividing your property.
- Get a valuation done when you vacate your Principle Place of Residence. If no valuation is done, then your accountant can always estimate the capital gain using a pro-rata method. E.g. If it was considered PPR for 5 years and an investment for 5 years, then they can just half the gain experienced over the 10 year period. But what if this is not what happened in reality and you end up worse off?
EXAMPLE 3. John bought his PPR in 2010 for $400,000. In 2015 he purchases a new PPR and so moves out of his old PPR and turns it into a rental property. (6 year rule does not apply given new PPR purchased!). John gets a valuation done at that time and the valuation on the old PPR is $500,000. In 2020 he sells the old PPR for $520,000. Using his valuation as an indication of what the property was worth when it became an investment he has a capital gain of just $20,000. Had he not got the valuation done, the only way to calculate the gain may have been to pro-rata it over the 10 years since he first purchased. As such, the gain would be $120,000 x 50% equals $60,000. So in this example a $300 valuation may well have saved John over $10,000.