A tax-free home

One of the big attractions of having your own home is the fact that any capital gain you make on its sale is tax-free.

Or, rather, it usually is. Unfortunately, Australia’s morass of tax laws contains plenty of rules and regulations that can result in a home being hit by at least some capital gains tax.

Sometimes the rules seem unfair. For example, if you work from home there is a risk that part of any future profit from its sale will be subject to capital gains tax.

As usual, this will depend on a range of factors, including whether or not the part of the home used for income generation was used for that purpose only.

An example would be several rooms used as a medical practitioner’s surgery. In contrast, a single room used by a professional for work should not affect the family home’s capital gains tax exemption.

There are more complex cases than this however, and one was recently raised by a Money reader. In this case, a house was purchased 10 years ago on a block on which it was legally permitted to build a second residence without subdividing or strata titling it.

The purchaser lived in the original house for five years while he built a second on the back of the block. He then moved into the new house and rented out the first.

When the time came to sell the property, he decided to do so without subdividing the original block. Remember, he bought the block with a house on it as his family home and simply "improved" the land by adding a second residence – a variation on the common theme of buying an old house and extensively renovating it.

So will he be hit by capital gains tax and if so, how will it be calculated?

Les Szekely of Deloitte Tax Services says that in contrast to profits made due to an extensive renovation of an existing house, a strict application of the law would result in capital gains tax being payable.

How much will depend on the precise details of the case. As a guide, Szekely says that it is likely that the tax will be calculated as follows:

• Half of the total sale price will be exempt as the land and original house were used solely as the family home for half of the period of ownership.
• It would then be necessary to estimate the likely value of the original house and its immediate surrounding land at the time it was first rented and again when the entire property is sold.
• Half of the difference between the value five years ago and the estimated sale value is then subject to capital gains tax.
• The remainder of the sale price for the total package of land and two houses will be exempt from capital gains tax under the family home concession. Szekely says the tax legislation is not really concerned about whether the two houses are on a single title since the capital gains tax exemption for the family home applies to what the legislation refers to as a "unit of accommodation". The title of the land is rarely relevant.

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