How to Utilise the CGT 6 Year Rule to Reduce Capital Gains Tax

Utilising the CGT 6 year rule

Many Australians turn to property investment as a way to build long-term financial security for their families. However, it’s important to be aware of the costs that come with it, 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 or help you avoid capital gains tax altogether. We discuss the details of the six-year exemption rule for CGT and its implications for your investment strategy. Understanding and applying the 6-year rule can lead to substantial tax savings for property owners.

Understanding Capital Gains Tax (CGT)

Capital gains tax (CGT) is the tax you pay on the profit made when you sell an asset, like an investment property. It’s not a separate tax on its own, it’s added to your income and reported in your annual tax return. For example, if you make $100,000 profit selling an investment property, this is added to your taxable income for the financial year (after applying any eligible discounts or exemptions). The capital gain is included in your assessable income for that financial year, which determines how much tax you need to pay.

Defining your 'main residence'

Identifying your main residence is crucial because it directly affects whether you’ll need to pay capital gains tax (CGT) when you sell the property. In Australia, your primary home is generally exempt from CGT, meaning you don’t pay tax on any profit you make from selling it. However, if the property isn’t considered your main residence, or if it was used to earn income, such as through renting or running a business, you may only receive a partial main residence exemption or no exemption at all. When a property is used to earn rental income, it is treated as an income producing asset for tax purposes, which can affect your CGT exemption. Determining which property qualifies as your main residence ensures you apply the right CGT treatment and avoid unexpected tax liabilities later on.

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 Tax 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. If you use your property for income-producing purposes or business activities before moving out, this may affect your eligibility for the continuing main residence exemption and could result in partial capital gains tax obligations. Typically, this change occurs when you move out for an extended period.

Eligibility criteria for the 6-year exemption

To take advantage of the 6-year exemption and reduce your capital gains tax (CGT) liability, it’s essential to understand the eligibility requirements set by the Australian Taxation Office (ATO). The main residence exemption under the 6-year rule is only available if the property was genuinely your main residence before you moved out and began to produce income, such as earning rental income. The ATO considers factors like the period of ownership, how the property was used, and your intention to return when determining eligibility.

A key condition is that you must not establish another main residence during the 6-year exemption period. If you do, you may lose the main residence exemption on your original property for that time. Additionally, the exemption only applies if the property is not used to produce income for more than six years in a row while you are absent. If you return to live in the property, the 6-year period can reset, allowing you to potentially use the exemption again in the future.

For property investors and homeowners, understanding these criteria is crucial to minimising capital gains tax cgt and ensuring you don’t face unexpected tax liability when selling your property. Always review your situation against the ATO’s guidelines and seek advice if you’re unsure about your eligibility for this valuable tax provision.

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.
• Rental periods are specifically considered when determining the length of the exemption, and the six-year rule can apply even if the property is rented out intermittently.
• 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.

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 until 2013 but later returned and moved back into your original home. You resided there until 2016, when another interstate job opportunity required you to move out again.

Under the six-year absence rule, you can treat the property as your main residence for up to six years each time you move out, provided you don’t nominate another property as your main residence during that period. Throughout this example, your property would continue to be classified as your main residence for CGT purposes, meaning you would be eligible for a full CGT exemption when you sell. This is known as the full main residence exemption.

During your second period of absence, your property would be considered your main residence until 2022, or until you purchase another property that you nominate as your main residence.

Once the six-year period ends (or when another property becomes your nominated main residence), it’s important to obtain a professional market valuation of the property at that time. This valuation serves as a record of the property’s market value when it stopped qualifying for the CGT exemption. If you later sell the property, only the increase in value after that valuation date would be subject to CGT. In other words, the valuation establishes a clear “starting point” for calculating your tax obligations and any taxable capital gain that accrues once the property ceases to be your main residence.

As for determining when your property becomes your main residence again after moving back in, the ATO doesn’t set a specific timeframe. However, living in the property for at least six months is generally considered a reasonable benchmark, with a longer period offering stronger support for your claim.

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 main residence CGT exemption.
2. 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.
3. If you use your main residence for income producing purposes (including rental income for property investors), you may be disqualified from claiming the main residence CGT 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.
4. 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.
5. 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.
6. 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.

Maximising your CGT savings with the 6-year rule

The 6-year rule is a powerful tool for property owners looking to maximise their capital gains tax (CGT) savings. By continuing to treat your property as your main residence for up to six years after moving out, you can earn rental income without immediately losing the main residence exemption. This means you can generate income from your property while still enjoying significant CGT exemptions when it comes time to sell.

To make the most of the 6-year rule, keep detailed records of when you lived in the property and the periods it was rented out. Combining the 6-year exemption with other CGT exemptions, such as the 12-month ownership discount, can further reduce your capital gains tax liability. Consulting with an accountant can help you develop a tailored strategy that takes full advantage of the main residence exemption and other available cgt exemptions.

By planning ahead and understanding how the year rule works, property owners can minimise their tax liability, maximise their tax benefits, and ensure they are making the most of their investment. Whether you’re a property investor or a homeowner, leveraging the 6 year rule can lead to substantial CGT savings over the long term.

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 net capital gain and CGT obligations. Eligible expenses, such as renovation costs, improvements, and legal fees incurred during the purchase or sale of the property, can be included in the cost base to reduce your taxable gain.
• Certain tax deductions may be available for expenses incurred during periods when the property was used to generate income, such as when it was rented out. These deductions can help offset your overall tax liability.

Avoiding common CGT mistakes

Navigating capital gains tax (CGT) can be complex, and there are several common mistakes that property owners should avoid to protect their main residence exemption. One of the most frequent mistakes is failing to keep accurate records of when the property was your main residence and when it was used to produce income. Without proper documentation, you may be unable to claim the main residence exemption and could face a higher capital gains tax liability.

Another mistake is exceeding the 6-year rule by renting out the property for more than six years without returning to live in it, which can result in losing the exemption for the period beyond six years. Additionally, if you establish another main residence during the 6-year period, you may forfeit the exemption on your original property for that time.

Foreign residents should be especially cautious, as they are generally not eligible to claim the main residence exemption, including the 6 year rule. Changes in residency status can have significant tax implications, so it’s important to review your situation regularly.

To avoid these CGT pitfalls, property owners should seek advice from qualified tax professionals, maintain thorough records, and stay informed about the latest tax rules. By doing so, you can confidently claim the main residence exemption and minimise your capital gains tax liability.

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 capital gains tax liability as much as possible, get in touch with the experienced team at Bonerath & Co. 

The 6-year exemption is a valuable tax provision that empowers property owners to reduce or even eliminate their capital gains tax (CGT) liability. By understanding the eligibility criteria and strategically maximising your CGT savings, you can make the most of the main residence exemption and the flexibility offered by the 6-year rule. Whether you’re moving for work, personal reasons, or investment opportunities, this rule allows you to maintain your main residence status and enjoy significant tax benefits.

With careful planning and the support of property tax specialists, property investors and homeowners can protect their wealth, minimise their tax liability, and achieve their long-term financial goals. The 6-year rule is an essential tool for anyone looking to optimise their property tax position and avoid unnecessary capital gains. By leveraging this tax provision, you can ensure your property works for you, both as a home and as a smart investment.

FAQs about the CGT 6 year rule

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

Yes. The six-year rule provides a CGT main residence exemption, which allows you to treat your main residence as your primary home for CGT purposes even while you’re using it as a rental property, for up to six years, as long as you don’t nominate another property as your main residence during that time.

If you sell the property within that six-year period, you can generally claim a full CGT exemption, meaning no tax is payable on the profit for the entire ownership period. However, if you sell it after the six-year period has ended, only the portion of time beyond the six year exemption period may be subject to CGT.

In short, the rule can significantly reduce or eliminate CGT, depending on how long you’ve been away from the property and whether you’ve claimed another main residence during that time.

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

Yes. The ATO’s six-year CGT exemption rule can also apply to investment properties that were previously your main residence. The rule allows you to continue treating the property as your principal home for CGT purposes for up to six years after moving out, even if it’s rented during that time.

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 annual income 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.

An 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?

If you are a foreign resident for tax purposes at the time you sell your home in Australia, you will generally not be eligible for the main residence exemption (including the six-year absence rule), meaning the full capital gain may be subject to CGT. Exceptions only apply where you satisfy the “life-events” test and other transitional provisions. Property owners anticipating becoming a foreign resident should carefully consider the CGT implications of any property sale.

Applying the six-year rule correctly can make a significant difference to your tax outcome. Every situation is unique, so it’s important to get advice before selling or renting out your property. Speak with the experienced team at Bonerath & Co. to ensure you’re maximising your CGT exemptions and protecting your financial position.

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