Capital gains tax and the six-year absence rule

Looking to find out more about the capital gains tax six-year absence rule for property? Amir Ishak, Principal Advisor and Client Director at Property Tax Specialists, explains what it’s all about.

Capital gains tax (CGT) is the contribution you have to make to the ATO if you make a capital gain on the sale of your investment property. Unfortunately, it’s an inevitable part of the investment journey for most people who make a profit when selling their property.

However, the tax legislation allows for a few exemptions and concessions, such as the six-year absence rule concession for capital gains tax on property, which could help property investors save thousands of dollars. Here’s an overview of the CGT concession for the six-year absence rule, including what it is and how it works, as well as some tips on additional CGT exemptions some property investors may be eligible for.

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What is the six-year rule for capital gains tax?

According to the Australian Taxation Office (ATO), if you sell a property that was used to produce assessable income (such as rental income, for example) and you earn a capital gain on the sale, it’s considered part of your annual income and will need to be reported in your income tax return (bearing in mind that CGT is part of your income tax, not a separate tax).

However, the ATO does allow taxpayers to claim certain capital gains tax concessions, depending on their circumstances.

For example, if your property is considered your principal place of residence, you generally won’t have to pay CGT on its eventual sale.

To prove to the ATO that a property is your primary place of residence (PPOR) or main residence (MR) (these terms are interchangeable), you will typically have to do all of the following:

• live in the property on settlement
• keep your belongings there
• use the property’s address to receive your postal mail and as your home on the electoral roll, and
• have all the utilities connected in your name

The capital gains tax six-year rule allows eligible property investors to treat their investment property as if it were their main residence for a period of up to six years and still qualify for this exemption.

So, just like an owner-occupier could sell their PPOR without triggering capital gains tax liability, you, as a property investor, can potentially do the same, provided that:

• you used the property as your main residence before using it as an investment property to generate income, and
• you don’t nominate another property as your main residence for the same time period

How does the CGT property six-year rule work?

Once a property is considered your main residence, you can move and rent it out for up to six years after you leave without triggering CGT, provided you don’t nominate another house as your main residence.

Many people end up using the six-year rule in situations where they can’t live in their home for some time; for example, due to relocating for work or obligations in another state. Instead of leaving it empty, they use the property to generate extra income for themselves and provide housing for others.

This means an investor in this situation can generate an income while maintaining the property as their main residence for tax purposes.

Another benefit of claiming the main residence exemption using the six-year rule is that it resets each time the property is re-established as the main residence, which can occur if you move back in within the six years. This means that each time you move back home, the six-year rule resets. So, you can claim the PPOR exemption, provided you meet the other criteria and you don’t move away for more than six years at a time.

Here are a couple of hypothetical examples to illustrate how the exemption could work in practice.

Example 1:

Louis currently owns a property in Sydney, which he purchased three years ago. He has lived in the home for as long as he has owned it and has, for tax purposes, declared it to be his MR.

Last month, he was offered a temporary work placement in Canberra, which he accepted. While there, the company paid for his lodgings at an Airbnb, so there was no need to treat any other property as his main residence.

In the meantime, he decided to rent out the property so that the house wouldn’t stand empty and could generate an income for him.

After six months, he was offered a permanent position in Canberra, which he accepted. He rented a property there for a year and a half, after which time he decided it was time to sell his Sydney property and buy a home in Canberra.

Louis had only been away from his main residence for two years, so the ATO allowed him to claim the main residence concession because of the six-year rule.

Example 2:

Margo purchased her first property in 2016, moved into it immediately and declared it her principal place of residence with the ATO. Since owning it, she has lived in the property, and it’s the address used for her postal mail and electoral roll registration. All the utilities are also connected under her name.

Margo lives in the property on her own, so during the pandemic in 2020, she decided to temporarily move out to live at her sister’s place, so that she wouldn’t need to be in isolation alone.

Because she was only temporarily moving out, her home remained her principal place of residence.

After a few weeks of living with her sister, Margo started investigating the option of renting out her property on a three-month lease agreement so that she could generate some extra income while away from the property.

She ended up securing tenants and rented out the property from April 2020 to June 2020.  After that, restrictions started easing up and she was ready to move back home.

Although she ultimately didn’t sell the property, she would still be eligible to claim the main residence exemption because of the six-year rule if she were to sell it.

CGT tips for property investors

There are a few additional capital gain exemptions that homeowners can claim, so it’s worthwhile knowing how you can take advantage of them. For example, even if you aren’t able to use the six-year rule, you may be able to receive or take advantage of:

• a 50% CGT discount where you have held your investment property for 12 months or more before selling it
• a partial CGT exemption if your investment property was used as a main residence for part of the ownership period before selling it; and
• the six-month rule, which allows you to keep two main residences (or PPORs) for six months in a situation where you buy your new home before selling the old one.

The ATO provides strict guidelines for legally minimising your tax liability and claiming these exemptions. It may help to engage a tax agent or property tax specialist to ensure you apply for any tax concessions you may be eligible for.

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Final reflections

The most significant CGT exemption offered to homeowners is the main residence exemption.

The good news is that like owner-occupiers, property investors can also claim the main residence exemption by using the six-year absence rule.

As long as you treat your property as your main residence and sell your property within six years of moving out, you can apply the six-year rule and qualify for the main residence exemption.

Unfortunately, as of July 2020, a foreign resident for tax purposes generally can’t claim the main residence exemption.

To discuss any matter relating to capital gains tax, the main residence exemption, or the six-year rule, you may like to consult a tax agent.

Cover image source: Olga Kashubin/Shutterstock.com