CGT 6 year Rule
Extending the main residence exemption to investment properties
In Australian federal tax, one of the advantages of an individual owing their own home is the exemption to Income tax under the Main Residence exemption under Subdivision 118-B of Income Tax Assessment Act 1997.
The Main Residence exemption means when a taxpayer sells their home, any capital gain is exempt from Income Tax.
However, the exemption is not easily applied, as there are many exceptions and rules that need to be considered. This is important given the Australian Taxation Office’s (ATO) increasing audit focus on taxpayers who fail to report the right amount of net capital gains from sale of a dwelling, especially where the gain is not fully exempt.
How does Main Residence Work?
Generally, a dwelling is no longer your main residence once you stop living in it.
In some cases you can choose to treat a dwelling as your main residence for Capital Gains Tax purposes even after you move out of it. This is what is called the ‘temporary absence rule’ (TAR) or the “six year rule”.
How does the Temporary Absence Rule work ?
Some of the basic factors for the TAR are as follows:
- For any period the dwelling is not used for income producing purposes after the taxpayer ceases living in it, the taxpayer can treat the dwelling as their main residence indefinitely.
- For any period the dwelling is used for income producing purposes, the taxpayer can treat the dwelling as their main residence for a maximum period of six years;
- Where a taxpayer makes this choice, they cannot treat any other dwelling as main residence for that period. This is: they cannot purchase another main residence and live there (with certain exeption see below). They of course can rent and access the exemption.
- A taxpayer cannot cease to use a dwelling as their main residence if the dwelling was never used as their main residence in the first place.
What happens if you rent out a dwelling for more than six years during a period of absence?
The ‘market value rule’ may kick in, which means you are taken to have acquired the dwelling at its market value at the time you first used it to produce income.
In other words, the exemption is not lost.
A partial main residence exemption will apply on its eventual sale instead.
Does the six 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 six 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 six year rule can apply each time the dwelling again becomes and ceases to be the taxpayer’s main residence. However, for a new six 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.
John lives in his home (which he bought in 2001) for the first three years. He then moved to interstate for work purposes and rented his home to tenants for four years. Then he moved back and lived in it for another three years. His home was again rented out for four 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 six year limitation is calculated separately for each period of absence and the rental period within each period of absence did not exceed six years. As a result, John was exempt from CGT.
What happens if a taxpayer owns more than one dwelling?
A taxpayer can still choose to apply the six year rule to a dwelling they have moved out of even if the taxpayer moves into another dwelling they own. The main residence exemption can only be applied to one dwelling during the overlapping period.
As a general proposition, the main residence exemption should be maximised for the dwelling that is likely to generate the greatest capital gain when it is sold.
Please contact our office if you want to discuss more about the main residence exemption.