Tuesday, 13 June 2023 / Published in Walshs Blog
Selling your rental property is a great opportunity to unlock some personal equity. But don’t forget the taxman wants a slice of the cake. Capital gains tax (CGT) is liable for the profits on the sale of property, however the capital gains tax 6 year rule provides some exemptions which can be utilised to optimise your tax position.
The Main Residence Exemption – AKA the Capital Gains Tax 6 Year Rule
The main residence exemption (MRE) is the most commonly used exemption from capital gains tax (CGT). It allows homeowners to sell their property without incurring CGT if it has been their main residence. This exemption extends for up to six years after moving out if specific criteria are met and is often called the ‘capital gains tax 6 year rule’.
During this period, if you don’t establish a new main residence (i.e. you stay in rented or short-term housing while you are away), you will qualify for the MRE. Furthermore, you can even earn rental income from your main residence and still qualify for the MRE.
Eligibility for the capital gains tax 6 year rule
In order to be eligible for the CGT exemption;
- Your property must have been your main residence first. You cannot apply the main residence exemption to a period before a property first becomes your main residence (e.g. if you rented out your home before you lived in it).
- You must have stopped living in the property.
- You must be an Australian resident at the time of sale. Foreign residents are not entitled to MRE.
You can elect for the MRE in your income tax return for the financial year in which the sale contract date falls. Additionally, if your main residence was being used to produce income, it is up to your discretion as towhen the MRE applies – up to the maximum 6-year limit.
The ATO created the capital gains tax 6 year rule to recognise the many circ*mstances under which you may not live in your property for some time. The rule will appeal to any homeowners who are thinking of making some additional income when unable to reside in their own home.
The following examples highlight various scenarios where the ‘capital gains tax 6 year rule’ can apply:
Scenario 1: A new main residence is established
Josh is earning rental income from his main residence in Brisbane for 4 years while he works and rents a property in Sydney. In 2020 Josh decides to purchase a property in Sydney, establishing a new main residence. Two years later , in 2022, Josh sells his Brisbane property.
Josh can claim the capital gains tax 6 year rule on his property for any gain in property value up until 2020. He will then only be liable for CGT on the change in property value from 2020 to 2022.
*Note: in this scenario it is crucial that Josh obtains a property valuation of his Brisbane property on the 2020 date that he moves out of his home.
Scenario 2: A period of absence from a main residence
For four years Josh earns rental income from his main residence in Brisbane while residing in a rented property in Sydney. Later, Josh returns to his Brisbane property, with no changes to his main residence. As Josh moves back to his Brisbane property, the six-year exemption for the MRE resets.
Scenario 3: Use of MRE
Kelly purchased an apartment in Brisbane on 3 April 2015, and moved into the property immediately. In September 2017, Kelly moved to Melbourne where she rented a property in St Kilda. At this time, Kelly listed her Brisbane property for rent. The Brisbane property was rented for two years. Kelly decided to sell the property on 30 March 2019. Kelly is entitled to the capital gains tax 6 year rule (or MRE) as she was only renting the property in St Kilda, and had lived in her Brisbane property after purchasing it.
If the above information is something you would like to explore further, we encourage you to contact us on 07 3221 5677 or email enquiries@walshs.com.au. You can also schedule a meeting with us by clicking on this booking link.
By: Rachel McGrath, Accountant | Walshs
FAQs
What is the CGT Six-Year Rule? The capital gains tax property six-year rule allows you to use your property investment as if it was your principal place of residence for up to six years whilst you rent it out.
What is a simple trick for avoiding capital gains tax? ›
An easy and impactful way to reduce your capital gains taxes is to use tax-advantaged accounts. Retirement accounts such as 401(k) plans, and individual retirement accounts offer tax-deferred investment. You don't pay income or capital gains taxes at all on the assets in the account.
Do you have to pay capital gains after age 70? ›
Whether you're 65 or 95, seniors must pay capital gains tax where it's due. This can be on the sale of real estate or other investments that have increased in value over their original purchase price, which is known as the “tax basis.”
Is there a way to avoid capital gains tax on the selling of a house? ›
You will avoid capital gains tax if your profit on the sale is less than $250,000 (for single filers) or $500,000 (if you're married and filing jointly), provided it has been your primary residence for at least two of the past five years.
How does the 6-year rule work? ›
If you use your former home to produce income (for example, you rent it out or make it available for rent), you can choose to treat it as your main residence for up to 6 years after you stop living in it. This is sometimes called the '6-year rule'. You can choose when to stop the period covered by your choice.
How do I reset my 6-year rule? ›
You have to re-establish the property as your main residence if you want to use the 6-year rule again. This can only be achieved if you move back in, and you consider and make it your main home. Just remember rules and guidelines may change and in 12 years' time there could be different rules in place.
Are there any loopholes for capital gains tax? ›
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
How do rich people avoid capital gains? ›
Billionaires (usually) don't sell valuable stock. So how do they afford the daily expenses of life, whether it's a new pleasure boat or a social media company? They borrow against their stock. This revolving door of credit allows them to buy what they want without incurring a capital gains tax.
How do I get zero capital gains tax? ›
Capital gains tax rates
A capital gains rate of 0% applies if your taxable income is less than or equal to: $44,625 for single and married filing separately; $89,250 for married filing jointly and qualifying surviving spouse; and.
At what age is there no capital gains tax? ›
For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.
You can sell your primary residence and be exempt from capital gains taxes on the first $250,000 if you are single and $500,000 if married filing jointly.
At what income do you not pay capital gains? ›
Capital gains tax rate 2024
| Filing status | 0% | 20% |
|---|
| Single | $0 to $47,025 | $518,901 or more |
| Married filing jointly | $0 to $94,050 | $583,751 or more |
| Married filing separately | $0 to $47,025 | $291,851 or more |
| Head of household | $0 to $63,000 | $551,351 or more |
1 more rowJun 4, 2024
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
Does selling a house count towards capital gains? ›
Capital gains tax. If you profit from the sale of a home in California, then you may owe some capital gains tax unless you qualify for an exclusion, which we'll address in the chart below. Capital gains are the profits make when you sell an appreciable asset, such as a house.
What costs can be deducted from capital gains tax? ›
Calculate Your Capital Gains Taxes Correctly
In addition to the home's original purchase price, you can deduct some closing costs, sales costs and the property's tax basis from your taxable capital gains. Closing costs can include mortgage-related expenses.
What is the IRS 6 year rule? ›
6 years - If you don't report income that you should have reported, and it's more than 25% of the gross income shown on the return, or it's attributable to foreign financial assets and is more than $5,000, the time to assess tax is 6 years from the date you filed the return.
How to avoid capital gains tax when inheriting property? ›
How to Avoid Paying Capital Gains Tax on Inheritance
- Sell the inherited property quickly. ...
- Make the inherited property your primary residence. ...
- Rent the inherited property. ...
- Disclaim the inherited property. ...
- Deduct selling expenses from capital gains.
While there is technically no limit to how often the home sale exclusion can be claimed (every time a home is sold), the qualification of having lived in a property for at least two out of the last five years means that an individual couldn't claim the tax break more than once every 2 years.
How do I avoid long term capital gains? ›
Invest for the Long Term: Hold your investments for longer periods to benefit from the Rs. 1 lakh exemption and potentially avoid LTCG tax altogether. Tax-Efficient Investing: Consider consistent performers and avoid frequent portfolio churning (buying and selling) to minimise taxable gains.
