One of the main advantages of an individual (s) owing their family home is the capital gain is usually tax free under the ‘Main Residence Exemption’.
The tax act also allows you to maintain the capital gains tax (CGT) exemption on your main residence if you have a 'temporary absence' for up to 6 years, as long as you are not claiming another property as your main residence at the same time. This applies even if the main residence is rented out during the period of temporary absence.
Note the 6 year temporary absence exemption only applies where the taxpayer would have been entitled to a full exemption if the sale of the dwelling occurred immediately before it was first used to produce income,. In other words, the taxpayer must have lived in the dwelling from the outset and then commenced to rent it out at a later time.
There are a number of different scenarios in which taxpayers may benefit from the 6-year exemption:
- You might move back in with your parents
- You might decide to move into shared accommodation to lower your outgoings
- You might commence a relationship and decide to live at your partners’ place, while renting out your former home
- You might decide to work interstate or overseas for a couple of years and rent out your home in the meantime while you rent accommodation near the new job
Example:
Joanna purchased an apartment 2 years ago in Brisbane and has lived in it ever since. She accepts a job offer in Melbourne and moves to rented accommodation in inner-city Richmond. She decides to rent out her own apartment in Brisbane to cover the mortgage repayments. She doesn’t want to sell it as it hasn’t really had time to go up in value yet, and she feels she will probably move back to Brisbane at some time in the future.
In Joanna’s tax return she has to declare the rent as income. However, she can also claim all of the outgoings relating to the property as deductible expenses. As the mortgage is only 2 years into a 30-year term, her interest costs are still quite high so she ends up being ‘negatively geared’, i.e. her expenses exceed her income and the ‘loss’ can then be applied against her other taxable income, resulting in a significant tax refund.
As long as Joanna is not claiming another property as her main residence, she can maintain the exemption for up to 6 years during this ‘temporary absence’ from her Brisbane property.
If Joanna decides after 5 years to move back into her apartment, then because she is within the 6-year exemption period she will not be liable for CGT when she eventually sells the property. She has enjoyed the tax benefits of negative gearing without the CGT consequences.
What happens if Joanna rents out the apartment for 10 years?
The ‘market value rule’ will apply which means that Joanna is deemed to acquire the property for its market value at the time she first started renting it out.
She is still entitled to the 6-year exemption and ends up paying CGT effectively only on the portion of the gain that relates to the other 4 years.
Does the 6 year rule apply to more than one period of absence?
The answer is yes. If you are absent more than once during the period you own the dwelling, the 6 year maximum period that you can treat it as your main residence while you use it to produce income applies separately to each period of absence. In other words, the 6 year rule can apply each time the dwelling again becomes and ceases to be the taxpayer’s main residence. However, for a new 6 year to kick start, the taxpayer must move back into the property and again treat as their main residence before it becomes income producing again.
Example:
John lives in his home (which he bought in 2005) for the first 3 years. He then moved to interstate for work purposes and rented his home to tenants for 4 years. Then he moved back and lived in it for another 3 years. His home was again rented out for 4 years before he sold it.
John can choose to treat the dwelling as his main residence for both periods of absence, even if the combined total of both periods is eight years. This is because the 6 year limitation is calculated separately for each period of absence and the rental period within each period of absence did not exceed 6 years. As a result, John is exempt from CGT when he eventually sells the property.
What happens if a taxpayer owns more than one dwelling?
A taxpayer can still choose to apply the 6 year rule to a dwelling they have moved out of even if the taxpayer moves into another dwelling they own. However, the main residence exemption can only be applied to one dwelling during the overlapping period.
As a general rule, the main residence exemption should be maximised for the dwelling that is likely to generate the greatest capital gain when it is sold.
The taxpayer effectively makes a choice as to which property they wish to claim the exemption when they lodge their tax return in the year that one of the properties is sold.
