Rent out your house and avoid Capital Gains Tax

It is possible to rent out your house without paying capital gains tax (CGT). The Australian Taxation Office allows capital gains tax exemptions for rental property under specific scenarios.

There are many reasons why you might wish to rent out your main place of residence — circumstances change and so do people’s plans. For those wishing to rent out their home without incurring CGT, it is important to carefully examine the ATO’s rulings on the subject.

As a rule of thumb, a few simple rules apply:

• The house in question must be your main dwelling to be exempt from CGT. In other words, you cannot own another property and live in that for a few years, then move back and forth between that and your main residence and avoid CGT on both properties.
• Generally, if you bought a house after August 20, 1996, you must have lived in it when you first bought it (as opposed to having rented it out) to be entitled to a full exemption. This comes under the “Home first-used to produce income” rule.
• On the proviso the above two points are met, if you rent out your home for less than six years, you are exempt from CGT.
• Assuming the ATO deems you are subject to CGT, if you hold a property for more than 12 months, you are entitled to a 50% CGT discount.

Beyond this point it all gets a bit complicated and depends on the individual’s circumstances, how many properties they own and how frequently they move.

Full exemptions: Assuming that the house is your sole dwelling, you may rent the house out for six years after you cease to live in it. After that, you must return to live in it for an acceptable period in order to be granted another maximum rental period of six years. This process can be repeated indefinitely. If you rent your house out for six years then leave it vacant thereafter, it remains CGT exempt.

Partial exemptions: In some cases, especially when several investment properties are purchased over the period, the six years are deemed to be cumulative. This means that you only get six rental years in total before incurring CGT. CGT however, will be exacted proportionately. So for example, if you rented your house out for eight years and made a capital gain of $400,000, you would only have to pay CGT on one quarter of the gain – the two years out of the eight that exceeded the six-year exemption. So CGT would be exacted on $100,000, which after taking into account the 50% discount for holding a property more than 12 months, would fall to $50,000. Check the ATO website for instances where this might apply.

Partial main residence exemptions after 1996: If you initially bought the house as a rental property after August 20, 1996, and then changed your mind and decided to live in the house, the property will be partially exempt from CGT on a proportionate basis of years lived in to years rented.

The following points also provide some rough but useful guides:

• Properties larger than 2 hectares are not exempt from CGT, although there are provisions for farmers.
• Residences held by private companies and trusts (deceased estates come under separate rules), etc, do not qualify for an exemption.
• If part of the house is used for income-producing purposes such as a home business, then CGT will be exacted on that portion of the house if you claim tax deductions such as rent, interest, rates and insurance.
• If you have bought a new house, but are in the process of selling the old one, you have a three-month window to complete the sale before the CGT kicks in.
• In the event of deceased estates, assuming the property was the sole residence of the deceased, a full exemption applies on the proviso the property is sold within two years of the deceased’s passing.

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