By: Noel Whittaker
Judging by emails I receive, capital gains tax (CGT) on the family home is causing a lot of confusion. It’s really not difficult, if you take it step by step, so today I will share some examples to help you understand it.
Your residence is free of CGT only if it is held in your personal names or in the name of one of you. If it is held by a family company or trust, there is no CGT exemption – this can cause a dilemma for professional people who are trying to shelter their assets. It often becomes a choice between protecting those assets or enjoying a CGT-free home.
Confusion can arise when two properties are owned at the same time, because the tax treatment depends on the order in which they were occupied.
Which property?
For example, a couple buy a property to live in, and then moves out of it to another home, retaining the first one as a rental. It will be free of CGT for the time they lived in it, so they will be liable for CGT only on any increase in value from the date they moved out of it until it is sold.
Another person buys a property, rents it out and then subsequently moves into it. In this case, the CGT is assessed on a pro rata basis. Suppose they bought the property in 2006 and had it rented till 2010, when they moved in. If it was then sold in 2016 they would have owned it for a total of 10 years. As it was rented out for four of those 10 years CGT would be payable on 4/10ths of any gain.
Deferring decision
You can rent out your home and be absent from it for up to six years without losing the CGT exemption, provided you don’t claim any other property as your principal residence in that time. However, if you move to another property and retain the first, you do not have to make an immediate choice.
Say you buy a home for $450,000 in 2011 and live in it until 2015, when you buy another for $800,000 which you move into. At this stage you do not have to nominate which house will be covered with the CGT exemption but you should still obtain a valuation of the first house when moving out of it, just in case you decide not to eventually exempt it. Five years later, both houses are worth $900,000. You wish to take the profit out of the first house, so sell it tax free under the six-year rule. This makes the second home liable for CGT from the date you bought it until 2015, but no CGT is payable until that house is sold. Furthermore, if you continue to live in it for a long time, any CGT that might be due in the future will be considerably reduced under the pro rata rule.
Death or taxes
There is an exception to the pro rata rule that can be used by savvy investors. If a property is your principal residence at the date of death, any previous CGT liability can be avoided.
A canny old businessman owned his own home, and also an investment property that was carrying a high unrealised capital gain. Feeling he was close to death, he moved out of his current residence into the investment property and treated it as his own home. When he died, the property was his own residence and was deemed to be acquired by his beneficiaries at its market value at date of death. His beneficiaries were delighted to discover they could sell the property CGT free within two years.
Source: The Sydney Morning Herald
