Capital Gains Tax (CGT) was a hot topic during the recent (July 2016) federal election. The upshot of it was that CGT is here to stay.
When it comes to property, CGT is usually only considered by property investors as the tax only applies for investment purchases and not your owner-occupied residence.
In my daily work, I come across clients that change “intent” during ownership of their home which then “potentially” raises the CGT issue. Careful planning will ensure you don’t get caught out with a big tax bill when and if you sell your home one day.
To help you better understand CGT relating to property, I wanted to outline the key events when CGT applies.
What is CGT and how does it work?
CGT was first introduced 20 September 1985. In simple terms, CGT applies when a CGT event occurs. A CGT event occurs when you sell an investment (e.g. an investment property).
To illustrate, let’s assume you purchased an investment property for $400,000 8 years ago and the purchase costs (e.g. stamp duty, etc.) were $22,000. The total cost was $422,000.
Today, you sell the property for $650,000. Your net proceeds (e.g. after agent costs, marketing, and the like) are $630,000.
The Capital Gain in this instance is $208,000 (i.e. $630,000 less $422,000).
A Capital Gain occurs when the Sale Price (net of selling costs) is greater than the Cost Base (which is made up of the purchase price plus transaction costs). This example assumes no depreciation has been claimed during the 8 year ownership period. If depreciation was claimed, this amount should be deduced from the Cost Base.
When it comes to property, the Australian Taxation Office (ATO) provides a CGT exemption in few circumstances.
Your Principal Place of Residence (PPOR) is exempt from CGT, which is fantastic as many of our clients have created strong equity (wealth) from buying and holding onto their homes. Once the home is sold (e.g. to downsize) the capital gain is CGT exempt.
Note, you can only have one property as your PPOR and be exempt from CGT. For example if you own a holiday home, then this property is not exempt from CGT.
Whilst your PPOR is exempt from CGT, there are a couple of rules (conditions) which apply and which you should be aware of, in case this ever applies to you.
These rules are commonly known as:
- The 6 year rule
- The 6 month rule
- 50% discount for Investors
The 6 year rule
This is a handy rule to know as I have seen many of our clients move out of their PPOR for a while due to work relocation (e.g. interstate or overseas). Rather than keeping your home empty collecting dust, many people choose to rent it out and collect rental income.
The ATO provides a CGT exemption up to 6 years after you vacate from your home. Even though technically your home is being used as an investment whilst you’re away, you can return to the home and not pay CGT should you decide to sell the home in the future, so long as you return within 6 years from the vacate date.
If this applies to you, check with the ATO to ensure your particular reason(s) for being away from your PPOR is acceptable, as the ATO has guidelines. Common reasons we have come across are… work relocation, looking after a sick relative, and taking an extended holiday.
Take note, whilst you’re away from you PPOR, you cannot treat any other property as your PPOR for CGT purposes.
The 6 month rule
This rule applies when you upgrade or purchase another home. If you buy a new home before selling your existing home, you’ll get the CGT exemption so long as you dispose of your older home within 6 months of purchasing the new home.
Other conditions that apply to this rule are:
- The older home was your PPOR for a continuous period of 3 months (within the last 12 months before you sold it)
- The older home was not tenanted during the last 12 months before you sold it
- The new home becomes your new PPOR
50% Discount for Investors
This mainly applies to Property Investors.
If you hold an investment property for 12 months or more, you are entitled to a 50% discount should you dispose/sell the property one day. In other words, the Capital Gain is halved before tax is applied.
The 12 months is worked out from contract date and not settlement date.
In summary, CGT is usually only concerned by property investors, however as you can see from the information above, you should be across the detail in case you change intent with your PPOR or change the usage of your PPOR.
Disclaimer: If you intend to rely on any of the above information, you should request advice from a registered tax agent. This information does not take into account your individual objectives, financial situation and needs. You should assess whether the information is appropriate for you and seek specialist advice from a qualified taxation advisor.