When it comes to property investment in Australia, understanding tax implications is crucial to ensuring that capital gains tax, if any, is kept to a minimum. One such key tax rule which you may have heard of is the 6-year rule for capital gains tax (CGT), which can provide significant tax relief to property owners. This blog will explain the 6-year rule, how it works, and the scenarios in which it can be applied.
Capital Gains Tax (CGT) Basics
CGT is the tax you pay on the profit made from selling an asset, such as real estate, shares, or other investments. The 6 year rule only applies to real estate, in particular, your principal place of residence. In Australia, your main residence is generally exempt from CGT under the main residence exemption. However, if you rent out your main residence or use it for income-producing purposes, you may have to pay CGT when you sell the property.
This is where the 6-year rule becomes important.
Understanding the 6-Year Rule
The 6-year rule allows property owners to treat their main residence as their primary place of residence for CGT purposes, even if they move out and rent it out, for up to six years. Essentially, you can rent out your property without losing the CGT exemption, provided you meet specific criteria.
How the 6-Year Rule Works
- Establishing a Main Residence: To qualify for the 6-year rule, the property must have been your primary residence before you moved out. This means you must have genuinely lived in the property and not merely owned it.
- Absence Period: Once you move out and rent out the property, the 6-year rule applies, allowing you to claim the main residence CGT exemption for up to six years.
- Re-establishing Residency: If you move back into the property and then move out again, the 6-year rule resets. This means another six-year exemption period can start.
- No Other Main Residence Claim: During the period the 6-year rule applies, you cannot claim another property as your main residence for CGT purposes. You must nominate only one property as your main residence.
We strongly recommend that you seek the advice of an accountant Melbourne who can advise whether your situation falls within the criteria to use the exemption.
Example of the 6-Year Rule in Action
Let’s say Sarah buys a house in 2015 and lives in it as her primary residence until 2018. She then moves interstate for work and decides to rent out the property. In 2023, Sarah kicks out the tenant and sells the house.
Because she rented out the property for less than six years (i.e. 5 years from 2018 to 2023), the 6-year rule applies, and she does not have to pay CGT on the sale, assuming she hasn’t claimed another property as her main residence.
Key Considerations
- Multiple Absence Periods: You can apply the 6-year rule multiple times if you move back into the property, as the rule resets when you re-establish it as your main residence.
- Partial Exemptions: If you rent out the property for more than six years, a partial CGT exemption may apply. The tax will be calculated based on the proportion of time the property was rented out beyond the six-year period. An accountant Melbourne can run through the calculations with you if not clear.
- Record Keeping: To claim the 6-year rule, keep thorough records of your living arrangements, rental agreements, and property usage to substantiate your claims. Best to seek the advice of a tax accountant Melbourne who can advise on what records to keep to enable the concession to be claimed.
When Does the 6-Year Rule Not Apply?
The 6-year rule won’t apply if:
- The property was never established as your main residence.
- You claim another property as your main residence during the absence period.
- You rent out the property for more than six years without re-establishing residency.
It’s very important to seek the advice of a tax accountant Melbourne who can create a strategy for you to ensure that you make the most of the concession. Used smartly, it is not uncommon to save hundreds of thousands of dollars in CGT in utilising the 6 year rule.
Is the 6 year rule too good to be true?
On the face of it, it may seem so. One of the reasons for the rule is it is designed to help those who, through no fault of their own, are required to move out of their principal place of residence for work purposes. The law allows them to rent out their place while they are living away for work without losing the principal place of residence CGT exemption. A useful aspect of the rule is that one can move out of the family home for any reason whatsoever (not just because of being relocated for work) and still claim the exemption.
Seek Professional Advice
While the 6-year rule can be extremely beneficial, navigating CGT laws can be complex. Consulting with a tax accountant Melbourne or property accountant is recommended to ensure compliance and to minimise your capital gains tax.
Final Thoughts
The 6-year rule provides Australian property owners with significant flexibility in managing their property while maintaining tax advantages. By understanding the rule and applying it strategically, you can potentially save hundreds of thousands of dollars in capital gains tax and maximise your wealth. Don’t hesitate to seek the advice of an accountant Melbourne, like Nobel Thomas, to create a strategy for you.
