October 13, 2023

How to Utilise the Six-Year Exemption Rule to Reduce Capital Gains Tax

How to Utilise the Six-Year Exemption Rule to Reduce Capital Gains Tax

Investing in property may assist in paving the way for a secure financial future for your family. Nevertheless, it's essential to be mindful of the expenses that accompany property investments, with one of the most significant costs being capital gains tax (CGT) upon property sale.

Fortunately, there are several CGT exemptions that can effectively reduce your tax liability. This article delves into the details of the six-year exemption rule for CGT and its implications for your investment strategy.

Understanding Capital Gains Tax (CGT)

Capital gains tax is levied on the profit realised from the sale of an asset, including property. It is important to note that CGT is not a standalone tax but is incorporated into your annual income tax return.

Defining your 'Main Residence'

Your primary residence, also known as your principal place of residence (PPOR), is the property where you reside full-time. Any property purchased for the purpose of renting out as an investment is considered a rental investment property.

The Australian Taxation Office (ATO) determines your property's main residence based on various factors, and no single criterion serves as the sole determinant. Typically, the ATO designates a property as your principal residence when:

  • You and your family live there, and you keep your personal belongings there.
  • This property serves as your primary residential mailing address.
  • You are enrolled on the electoral roll at this address.
  • Your property has all the standard utilities connected in your name.

If you meet some but not all of these criteria, the ATO will review your situation individually to make a qualified decision.

Determining when your home ceases to be your main residence

When you no longer meet most of the main residence criteria mentioned above, your property is no longer considered your main residence. Typically, this change occurs when you move out for an extended period.

Does the 6-year CGT exemption apply to your main residence?

The six-year exemption rule applies to your main residence and serves to reduce the CGT you must pay when selling it.

 If the property has appreciated in value, you may still be liable for CGT when selling it, regardless of its category.

Does the 6-year CGT rule apply to investment properties?

Yes, the ATO's six-year CGT exemption rule also applies to investment and rental properties. Further details on this are discussed below.

Understanding the 6-year Capital Gains Tax exemption

A common question regarding CGT on property investments relates to when a property's main residence status begins and ends. What happens when you stop residing in your home and later decide to sell it? This is where the six-year CGT exemption rule comes into play.

Once your property no longer meets the ATO's main residence criteria, you can still claim it as your principal place of residence for up to six years. This is commonly referred to as the six-year absence rule or six-year exemption.

The duration of the CGT exemption period depends on how you utilise the property after leaving it:

  • If you rent it out, it can remain your main residence for up to six years.
  • If you do not rent out the property, it can remain classified as your main residence indefinitely.
  • The six-year CGT exemption for the main residence is calculated on a daily basis. If you reach six years minus one day and cease renting the property, you can continue to own and treat it as your principal residence indefinitely.

Moreover, there is no strict limit on the number of times you can access this exemption, as illustrated in the following example:

Example: The 6-year capital gains tax exemption in action

Imagine you purchased a property in 2005 and lived in it for four years. In 2009, you obtained a job in another state, prompting you to move out and rent out your home.

You rented the property out until 2013 but then returned and moved back into your original home. You resided there until 2016 when you found another job in a different state. You were allowed to move out again and access another six-year absence period.

Throughout this entire period, your property was classified as your main residence for CGT purposes, granting you a complete exemption from paying CGT upon its sale.

During this second period of absence, your property would be considered your main residence until 2022 or until you purchase a new property classified as your main residence during this time.

It is advisable to obtain a comprehensive market valuation of your property at the end of this six-year period. This will provide you with an accurate price and clear documentation outlining the capital gain during the time when your property is not your main residence.

As for determining when your property becomes your main residence again after moving back in, the ATO does not provide a precise answer. However, it is reasonable to consider a period of six months or more as a starting point, with a longer duration being more favourable.

Is it possible to have two primary residences in Australia?

Yes, you can have two primary residences, but complexities arise when you own more than one property, especially if you live in both for extended periods.

Does the ATO 6-year rule apply to two main residences?

While you may technically have two principal residences, you can designate only one as your principal place of residence for CGT purposes.

For instance, suppose you have lived in one property and then moved into a second property for an extended period. Under the six-year absence rule, both properties could potentially be considered your main residence for the first six years after moving out of the first property. This raises the issue of determining which property qualifies as your main residence for CGT purposes when you sell either property.

You do not need to make this decision until you sell your property and file your tax return. At that point, you can assess the capital gains on both properties and choose which one provides the most tax benefits as your main residence.

Your accountant can assist you in determining which property will yield the most tax-effective benefits.

Can foreign residents benefit from the 6-year CGT rule?

Recent government rulings have impacted the eligibility of foreign residents to claim this exemption.

Under these new rules, effective from 1 July 2020, if you are classified as a foreign resident, any property sale will be fully taxable, even if the property is technically considered your main residence during that time.

Therefore, if you plan to sell your home and anticipate becoming a foreign resident in the near future, you should carefully consider the CGT implications.

Six facts about the 6-year primary residence exemption rule

  1. When claiming a six-year principal residence exemption on your CGT, you can do so only in your individual name. Properties held within trusts or company structures are not eligible for this exemption.

  1. As an individual, you can typically have only one main residence at a time. However, certain provisions allow you to have two primary residences when you are in the process of moving, but this is available for a limited six-month period.

  1. If you use your main residence to generate income, you may be disqualified from claiming the exemption or may be eligible for only a partial exemption. For instance, if you rent out your property or run a business directly from the premises, you may not qualify for the full exemption.

  1. Operating a home office is different, as long as you are not actively running a business or deriving income from your home. In this case, you can still claim the exemption. However, as soon as you use your property as business premises, such as a workshop, garage, or salon, you are likely to receive only a partial exemption.

  1. The main residence exemption is available only for land with property on it; you cannot claim the principal residence exemption for a vacant block of land.

  1. The term 'main residence' applies to up to 2.5 hectares of land. If your property exceeds 2.5 hectares, you can only receive an exemption for your home and the surrounding 2.5 hectares.

What to remember when applying for the 6-year CGT exemption 

The six-year exemption is not the sole method for reducing your main residence CGT obligations:

  • properties acquired before the 20th of September, 1985, are exempt from CGT.
  • If you’ve purchased a property within your self-managed super fund (SMSF) and the SMSF has owned the property for more than 12 months, you can claim a CGT discount if you’re still in the accumulation phase. If you’re in the pension phase, you may not need to pay CGT at all.
  • You may also be able to increase your asset cost base to lower your CGT obligations. 

How to apply for the 6-year CGT exemption

Navigating CGT can be complex, so it is essential to understand when exemptions come into play. To ensure that you qualify and minimise your CGT liability as much as possible, get in touch with the experienced team at Bonerath & Co. 

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