Puzzled by the 6 year rule in CGT?
Whether you’re an investor looking to grow your real estate portfolio or a homeowner ready for a change of scenery, understanding the capital gains tax (CGT) rules is crucial.
One regulation that often confuses folks is the 6 year rule. Before we break it down, here’s what we’ll cover in this article:
- Definition and overview of the 6 Year Rule for CGT
- Explanation of Capital Gains Tax and its implications for properties that are not the main residence.
- Details on the 6 Year Exemption for CGT, including examples and how it works with investment properties.
- Comparison between the 6 Year Rule and the Main Residence Exemption for CGT.
- Application scenarios for the 6 Year Rule, including renovations, temporary residence, inherited properties, and partial exemptions.
- Strategies to maximize the benefits of the 6 Year Exemption, including property holding considerations and renovation tips.
- Explanation of partial exemptions in CGT and how to calculate them.
- Additional CGT scenarios and exceptions, such as inherited properties, changing properties, granny flats, and foreign properties.
- Other tax deductions and concessions available in relation to property investments.
What is the 6 Year Rule for Capital Gains Tax?
In simple terms, the 6 year rule determines whether the profits from the sale of a property are subject to capital gains tax.
If you’ve owned a property for more than 6 years, the capital gain may be exempt from CGT when you sell it, provided the property was your main residence before it was rented out, and you did not rent it out for more than 6 consecutive years while living elsewhere.
However, 6 Year Rule does not automatically exempt any property owned for more than six years from CGT.
It specifically applies to properties that were initially your main residence, then rented out, allowing you to claim the property as your main residence for up to six years of the rental period, provided no other property is designated as your main residence during this time.
Here’s a little decision chart to help you figure out your next step:
But like many tax rules, there are a few nuances to keep in mind. The 6 year period is calculated based on ownership, not occupation.
It’s important to note that eligibility for the CGT exemption under the 6-Year Rule also depends on your residency status at the time of the sale.
As of July 1, 2020, non-residents cannot claim the main residence exemption, impacting those who change their residency status while owning the property.
Understanding what capital gains tax is is key here. It’s a tax on the profit you make from selling an investment asset that has increased in value. For property, it applies to homes that don’t qualify as your main residence.
The 6 Year Exemption – How It Works
Let’s use an example to illustrate.
Say you purchased an investment unit in Sydney for $500,000 in 2012 and rented it out until 2018, then decided to sell.
Normally, if you sold that unit for $700,000, you would have to pay CGT on the $200,000 capital gain.
However, under the 6 Year Rule in CGT, if the property was your main residence before you started renting it out, and you did not treat another property as your main residence during this period, you can potentially claim this period as exempt from CGT.
Because you rented out the property for exactly six years, you can claim the exemption for the entire period it was rented. Thus, the $200,000 profit could indeed be exempt from CGT.
Note: This exemption only applies if the property was your main residence prior to renting it out and no other residence has been claimed during the rental period.
The exemption applies specifically to the period it was rented out, up to six years. If these conditions are not met, CGT may still apply
Keep in mind that things can become more complex if you lived in the property at any point during the rental period or made significant renovations.
Such changes can affect the property’s cost base and might impact the calculation of your capital gain when you sell.
The Main Residence Exemption
It’s also important to distinguish the 6 year rule from the main residence exemption for capital gains tax.
If the property was your main residence (where you truly live), different CGT rules apply that are generally even more favourable.
Any gain from selling your home that was your main residence is typically completely exempt from CGT, regardless of how long you owned it for. Though there are limits if the property is over 2 hectares.
So in summary, the 6 year rule is a handy CGT exemption for investment properties owned for over 6 years.
But remember, when it comes to your principal place of residence, you’re already covered by the main residence exemption.
Applying the 6 Year Rule CGT – 4 Common Scenarios to Consider
Now that we’ve covered the basics, let’s look at some common situations where the 6 year capital gains tax rule comes into play:
Example #1: Renovating an Investment Property
Made some upgrades over the years? No worries – : You can still claim the 6-year rule exemption if the property was primarily your residence and temporarily vacant during renovations.
However, any period of residence during renovations needs careful documentation to ensure it does not affect the eligibility for the 6-year exemption.
However, any construction costs will get added to your cost base when calculating capital gain. So be sure to keep solid records.
Example #2: Moved Back In Temporarily
What if you needed to stay in your investment property for a short period, like during a home renovation?
As long as it wasn’t treated as your main residence, periods of minor personal use (up to 6 years total) are ignored for CGT purposes. You can still claim the exemption if the ownership period exceeds 6 years.
Example #3: Inherited Properties
The 6 year rule is based on the ownership period of the previous owner(s). So if you inherit grandad’s beach house he purchased 20 years ago, you immediately qualify for the CGT exemption when you decide to sell.
Example #4: Partial Exemptions
Things get a bit more complex if you used the property as both a residence and rental at different times. In this case, you may be eligible for a partial 6 year exemption on a pro-rata basis. More on this in the advanced section.
How to Maximise the 6 Year Exemption on CGT
Savvy property investors often align their buying and selling strategies around tax planning opportunities like the 6 year rule.
Some approaches to consider:
Holding Properties Long-Term
The longer you own an asset, the more time you have to qualify for full or partial CGT exemptions. A long-term buy-and-hold strategy gives you flexibility.
Renovate Ahead of Sale
Making improvements just before selling can increase your capital gain. But as long as you meet the 6 year threshold, those profits are tax-free.
Sell Underperforming Assets
If a property hasn’t delivered the expected returns, you may want to sell once you cross that 6 year mark to avoid capital gains tax erosion.
How to Calculate Partial Exemptions in CGT
We’ve covered the straightforward cases where the entire capital gain is exempt after 6 years of ownership.
But what if you used the property as both a residence and rental at different times? This is where partial exemptions come into play.
The 6 year rule allows for a CGT exemption on a property used as the main residence before being rented out, for up to 6 years of rental period.
The calculation works like this:
Capital Gain x (Non-Exempt Ownership Period / Total Ownership Period) = Taxable Portion
Let’s use an example:
- Purchase Price: $600,000
- Sale Price: $900,000
- Capital Gain: $300,000
- Ownership Period: 10 years
- Lived there as residence: 3 years
- Rented out: 7 years
Calculation:
Non-Exempt Period = 3 years
Total Period = 10 years
Taxable Portion = $300,000 x (3/10) = $90,000
So in this scenario, $90,000 of the $300,000 capital gain would be taxable, while the remaining $210,000 is exempt under the 6 year rule partial exemption.
As you can see, tracking the specific dates and use periods is critical for getting these calculations right. Keeping meticulous records from purchase to sale is a must for investment properties.
Other Scenarios & Exceptions on the 6 Year Rule CGT
While the 6 year rule covers many investment property situations, there are a few other scenarios and exceptions to be aware of:
Inherited Properties
As mentioned earlier, you inherit the acquisition date and costs from the deceased owner. However, special rules apply if assets were acquired before 20 September 1985.
Changing Properties
If you purchased a new investment property to replace your main residence, you may be able to access exemptions and concessions. But strict timeframes and conditions apply.
Granny Flats
Building a granny flat or separate dwelling can create some CGT complexities in terms of apportioning costs and using the 6 year rule. Careful planning is advised.
Foreign Properties
Australian tax residents are generally taxed on capital gains from worldwide assets. The 6 year rule applies, but other foreign taxes may also be payable.
Marriage/Relationship Breakdown
In the event of marriage or relationship breakdowns, there are CGT exemptions and roll-over provisions for assets transferred to a spouse.
While this isn’t an exhaustive list, it highlights some of the other layers of complexity in Australia’s CGT system. These nuances are why professional tax advice is highly recommended, especially for high-value transactions or complex scenarios.
Remember to Keep Excellent Records!
Accurate recordkeeping is essential when it comes to investment properties and capital gains tax.
From the date you acquire the property, be diligent about tracking:
- Purchase and acquisition costs (stamp duty, legal fees etc.)
- Period of ownership
- Periods of use as a main residence vs rental
- Details and costs of any renovations/improvements
- All income and expenses related to the property
- Sale price and incidental costs when you sell
Good documentation makes life much easier when the time comes to calculate capital gain and any 6 year rule exemptions. The ATO requires records to be kept for at least 5 years after the relevant CGT event.
Consider using a cloud storage system or app to keep all your property paperwork organized and accessible. Scanning paper receipts can also help create a digital paper trail.
Other Property Tax Deductions & Concessions
While the 6 year rule is one of the biggest capital gains tax concessions, there are some other deductions to be aware of:
- 50% discount if the property was owned for more than 12 months
- Tax deductions for property investment expenses
- Small business CGT concessions if the property is used in running a company
- Various CGT rollovers when transferring assets in specific situations
Each of these involves its own set of conditions and calculations. But combined, they can provide significant tax savings when buying, holding or selling investment properties.
Getting Professional Tax Advice
This guide covers the key concepts around the 6 year capital gains tax rule. However, as you can see, Australia’s CGT regime is complex with many moving parts.
For any substantial property transactions, it’s highly recommended to engage a tax professional familiar with the intricate CGT laws.
A tax agent, accountant or specialist can:
- Ensure you’re claiming all deductions and concessions
- Optimize your tax structure for investments
- Advise on implications of renovations, subdivisions, etc.
- Clarify grey areas and manage any disputes with the ATO
- Provide peace of mind that you’re playing by the rules
While some may view it as an added expense, the tax savings and risk mitigation is often well worth the cost of professional tax advice, especially for property investors with significant assets.
The 6 year rule is just one piece of a broader capital gains tax puzzle. Combining it with other concessions, meticulous recordkeeping, and expert advice can supercharge your property investment strategy.
This rule is complex and has various nuances that can affect eligibility and application. It is advisable to consult with a tax professional to ensure compliance and to optimize your tax outcomes, especially in scenarios involving significant property values or complex living arrangements.
As the old saying goes – it’s not what you earn, but what you keep that matters most.
FAQ Section on 6 year rule CGT
Do you have to live in a house for a year before renting in Australia?
No, there is no mandatory requirement to live in a house for a year before renting it out in Australia. However, living in the property as your primary place of residence before renting it out can have implications for capital gains tax exemptions, particularly under the six-year rule.
You can read more about this in Soho’s article, How Soon Can I Rent Out My Home After Buying Owner Occupied Property?
Do you pay tax when you sell a house in Australia?
If the house sold was your primary place of residence, you typically do not have to pay capital gains tax (CGT) in Australia. However, if the property was an investment or did not qualify as your main residence throughout the entire ownership period, CGT may apply.
Can you have two primary residences in Australia?
You cannot have two primary residences for CGT exemption purposes at the same time in Australia. The law allows a single main residence exemption at any one time, which is crucial for determining CGT liabilities.
How to calculate tax on selling a house in Australia?
To calculate the tax on selling a house in Australia, subtract the original purchase price, along with any associated costs (such as improvements, buying, and selling costs) from the selling price.
The difference is your capital gain, on which CGT may apply if the property is not your primary residence or other exemptions do not apply. For properties owned more than a year, a 50% CGT discount may apply for Australian residents.
