To paraphrase the late Kerry Packer, anyone who doesn’t try to minimise their tax bill should have their heads examined. Depending on your income level, capital gains tax or CGT when it comes time to sell your investment property could cost as much as 45% of the profits. If you’ve made $200,000 in profit, that’s $90,000 straight to the taxman.
However, what if you could avoid such a cost impost? This is where the six year CGT rule may come in handy - but it’s not necessarily your ‘get out of jail free’ card.
Advertisement
Buying an investment property or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for investors.
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | LVR | Lump Sum Repayment | Additional Repayments | Split Loan Option | Tags | Features | Link | Compare |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
6.19% p.a. | 6.58% p.a. | $2,589 | Principal & Interest | Variable | $0 | $530 | 90% | Featured 90% LVR |
| |||||||||
6.29% p.a. | 6.20% p.a. | $2,473 | Principal & Interest | Variable | $0 | $0 | 80% | Featured Apply In Minutes |
| |||||||||
6.19% p.a. | 6.23% p.a. | $2,447 | Principal & Interest | Variable | $0 | $595 | 80% | |||||||||||
6.34% p.a. | 6.59% p.a. | $2,486 | Principal & Interest | Variable | $248 | $350 | 70% |
| ||||||||||
6.39% p.a. | 6.41% p.a. | $2,499 | Principal & Interest | Variable | $0 | $250 | 80% |
What is the six year CGT rule?
Also called the ‘absence rule’, this rule essentially means you are able to treat your investment property as your primary place of residence (in a tax sense) for up to six years.
Under this rule, you can use the property to produce income such as rent for up to six years without attracting CGT for those six years if you sell it. The rule can be used indefinitely if it is not used to produce income e.g. if it sits empty or you use it only as a personal holiday home.
The main catch is: You cannot treat any other property as your main residence, except for up to six months if you are moving house. This basically means if you want to live somewhere else domestically for any ongoing and official capacity, you’d need to rent or have generous friends or family.
Mark Chapman, director of tax communications at H&R Block, told Savings.com.au this is an important rule for homeowners who may need to leave their home for a period of time.
“A home owner may get a job abroad or inter-state for a period of time and may choose to rent out their property whilst they are away, fully intending to move back in when their contract ends – it simply wouldn’t be fair not to apply the main residence exemption in such circumstances,” Mr Chapman said.
What is a PPOR?
To satisfy the Australian Tax Office under the six year rule, the residence must have genuinely been a PPOR, or primary place of residence. The dwelling must have been your main residence first, and to qualify for the CGT exemption you must have actually stopped living in it.
Mr Chapman said this is the main caveat emptor.
“You need to remember that the absence rule applies only where the property is genuinely empty, irrespective of whether the property is used to produce income,” he said.
“If you remain in the house but rent out part of it - say, on Airbnb - the absence rule doesn’t apply because you are still living there.
“Attempts to ‘game the system’ are a sure-fire way of attracting the attention of the Australian Tax Office.”
Small businesses and homes used for income before moving out
This is where it gets tricky. If you operate out of your home as a small business owner, such as a masseuse, consultant or other profession, any part of the house used for that profession will be subject to CGT.
For example, if you estimate 25% of the dwelling was used for the business, 25% of the total capital gain will be subject to CGT when you sell the home, while 75% will not under the six year rule.
For example, if you make a $100,000 capital gain after two years of owning it, $25,000 of that will be subject to CGT, although at a 50% discount for holding the asset longer than a year. So if your top marginal income bracket is 45%, 22.5% of $25,000 equals $5,625 payable in capital gains tax.
What happens if you move more than once?
For a new six year period to trigger, the homeowner must move back into the property and treat it as their main residence before it produces income again.
To quote the ATO: “If you are absent more than once during the period you own the property, the six-year period applies separately to each period of absence.”
Mr Chapman said the cycle can continue indefinitely.
“If you rent the property out for, say, five years, then move back in for six months, then rent out the property again for another five years, your entire capital gain will be tax-free,” he said.
“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.”
What happens if the six year limit is exceeded?
Any time spent producing income on your PPOR beyond the six year threshold will be subject to CGT. For example, if you sell the home after seven years, you’ll be subject to CGT based on that one extra year provided you’ve labelled it as your PPOR for those initial six years.
Case Study - Saving on CGT
Lou Pole buys his Brisbane PPOR in 2010 for $500,000. In 2012 he needs to care for his sick sister in Perth. He moves in with her and lucky for him he doesn’t need to pay rent.
He decides to rent out his Brisbane place, but keeps treating it as his PPOR for tax purposes.
Three years later, he decides to sell the house. He sells it for $700,000 - a $200,000 gain.
His top marginal income tax bracket is 32.5c on the dollar, so without the six year rule, he would have been on the hook for $32,500 in capital gains tax. But thanks to the six year rule, he isn’t taxed a cent on this profit.
Lou Pole decides to use that money ‘saved’ to buy his sister a Mazda 3 - nice brother.
Six year CGT rule - pros and cons
The most obvious pro is that you can avoid paying a lot of tax, while the obvious con is that you could be limited in where you live if your property is considered your PPOR.
Pros
-
Save on tax: The rule is designed to limit prohibitive cost burdens when leaving a property albeit only temporarily, such as a stint overseas or at a new job placement.
-
Flexibility: Say you need to move to another home for a temporary period, whether to care for a sick loved one or temporary work placement. The six year rule allows you to rent out your PPOR and not attract CGT if you sell within this time.
Cons
-
You might need to rent: You can’t buy another home and classify it as your PPOR while taking advantage of the six year rule. This means you might need to rent - unless you have very generous friends and family who will let you live at their place for up to six years. If you are renting, you will need to weigh up the costs versus the potential money saved on CGT.
-
Inflexibility: While a potentially convenient option if genuinely having to move out of your home for a short period, if you move out specifically to take advantage of this CGT rule, the hurdles that come with investment properties and then finding your own place to live might be a headache.
Photo by R Architecture on Unsplash
For tax advice relevant to you, visit the ATO or consult an independent tax advisor.
Ready, Set, Buy!
Learn everything you need to know about buying property – from choosing the right property and home loan, to the purchasing process, tips to save money and more!
With bonus Q&A sheet and Crossword!
Denise Raward
Brooke Cooper
Harry O'Sullivan
William Jolly
