Typically, when you sell an asset you must pay capital gains tax (CGT) on any profit which you make on the sale.
For most of us, the most valuable asset which we own is our family home and with house prices heading upwards across large parts of the country, many of us stand to make a large profit if we sell.
So does that mean that you have to pay CGT when you sell your house?
Fortunately, in most cases, the answer is no. The tax law provides an automatic exemption for any capital gain (or loss) which arises when a taxpayer sells their main residence.
However, this isn’t a blanket exemption. There remain situations where some or all of the gain arising on disposal of your main residence may be liable for CGT.
In this article, we look at what the phrase “main residence” actually means and look at some of the situations where the CGT exemption might not be available.
What is my Main Residence?
In short, it’s your home.
The ATO has set out some of the factors which it looks for in determining whether the property you have disposed of is your main residence. These include:
- Whether you and your family live there;
- Whether you have moved your personal belongings into the home;
- Whether your mail is delivered to the property;
- Whether the residence is your address on the electoral roll
- Whether you have services and utilities connected (for example, phone, gas, or electricity);
- Whether you intend the dwelling to be your main residence.
There is no minimum time that you have to live in a home before it can be considered to be your main residence, although a period of greater than 3 months is often taken as the benchmark. Even if you only own a house for a short period – six months, say – provided you tick all the boxes above, the property will be your main residence.
The main residence exemption can only apply to a property which includes a dwelling, ie anything that is used wholly or mainly for residential accommodation.
Examples of a dwelling are:
- a house or cottage;
- an apartment or flat;
- a strata title unit;
- a unit in a retirement village;
- a caravan, houseboat or other mobile home.
Simply owning land isn’t enough to claim the exemption, even if you intend to build a dwelling at a later date. However, you can choose to treat land as your main residence for up to four years before a dwelling is constructed in certain circumstances. You can choose to have this exemption apply if you acquire land and you:
- build a dwelling on the land
- repair or renovate an existing dwelling on the land, or
- finish a partly constructed dwelling on the land.
There are a number of conditions that you must satisfy before you can claim the exemption. You must first finish building, repairing or renovating the dwelling and then:
- move into the dwelling as soon as practicable after it is finished
- continue to live in the dwelling as your main residence after it becomes your main residence, ideally for at least three months.
And what about the land surrounding the house?
The CGT exemption includes any land adjacent to or surrounding the house, to the extent that that land is used for private or domestic purposes in association with the dwelling. What that means is that a garden is fine but an agricultural field is not.
To qualify, the land, together with the land on which the house sits, should not exceed 2 hectares in area. Anything over 2 hectares would not be covered by the exemption and a gain (or loss) would arise on the surplus part. The taxpayer can choose which 2 hectares to include but it must include the land on which the house is situated.
Can I Earn Income from My Main Residence?
Increasingly, people are using their home to produce income. Sometimes they do that by renting out part or all of the property, sometimes they do it by running a business from home. In the last few years in particular there has been a boom in the number of home-based businesses. If you tick one of those boxes, you may be forsaking part of your CGT exemption. This is because you cannot usually obtain the full main residence exemption if you used any part of your home to produce income during all or part of the period you owned it.
If you use your home to produce income, you are generally only entitled to a partial main residence exemption. That could affect you in one of three ways:
- You might use all of the home to generate income whilst you are absent, perhaps by renting it out. The period you are absent will not qualify for the main residence exemption and you’ll need to calculate the chargeable part by multiplying the total gain by the number of days the home wasn’t your main residence, multiplied by the number of days you owned the property in total. This is subject to the “six year absence” rule (see below) which allows you to earn income from a property from which you are absent for up to six years in certain circumstances and still claim the full exemption.
- You might use part of the home to generate income, for example by renting out a room or running a business from a designated home office. In that case, you won’t qualify for the main residence exemption for any part of the house which is used in your income earning activity.
If you are affected, you will need to calculate how much of the profit on disposal of your house is taxable. In most cases, this is done by working out the proportion of the floor area of the home that is set aside to produce income over the period the home was used to produce income and applying that to the capital gain.
- You might do both of the above, in which case you’ll need to perform both calculations for the relevant period of income earning activity.
Special rule for first income producing use
The above rules are further complicated by an additional rule that applies where you have lived in the property for some time without generating income from the property and then commence an income earning activity.
In that case, you are taken to have acquired the dwelling at the first time it was used to produce income for its market value at that time. This effectively wipes out the tax history of the property up until the time you started your income earning activity.
TIP: If you start to earn income from your property for the first time, you will need to get a market valuation for the property on the date you commence your income earning activity. It makes sense to get a market valuation done at that date by a qualified valuer.
Renting out the whole property – the “six year absence” rule
In some situations, it is possible to continue to enjoy a full Main Residence Exemption event though you are totally absent from the property and are earning income from it, possibly through renting it out.
If you own a property which is currently your main residence you can move out of the property for up to six years and still get the full exemption provided no other property becomes your main residence during the absence.
During that time you can earn rental income on the property and claim a tax deduction for expenditure as you would with a normal investment property. It isn’t necessary to move back into the property before the disposal for the ‘six year absence rule’ to apply.
Note that the “six year rule” resets each time you move back into the property and live in it as your main residence. That means that if you move back in and then later move out again, renting the property to tenants, you get a further six year absence period during which the main residence exemption is protected. In theory, that cycle can continue indefinitely until the property is finally disposed of.
The six year concession can only apply if the house has actually already qualified as your main residence.
TIP: If you purchase another property whilst absent, you only need to make the choice as to which property to treat as the main residence on disposal of the first dwelling, not at the time of the absence. This gives you an opportunity to plan and to pick the property with the better tax outcome.
TIP: If the property is merely left vacant (and not rented out or otherwise used to generate income), the main residence exemption will continue to apply indefinitely, provided you don’t acquire another main residence elsewhere.
Mark Chapman is the Director of Tax Communications at H&R Block.