Investment properties are usually subject to capital gains tax (CGT). This means that a portion of the money you make as profit on real estate assets is given to the government when you sell. This can be a substantial sum, potentially worth hundreds of thousands of dollars and is usually based on your individual income tax rate.
Obviously, it’s not a tax that investors love to pay. Thankfully, your primary place of residence is exempt from this tax, as it allows home owners to not have their own residence treated as an investment. Clearly, paying this tax as a home owner would also impact on their ability to upsize or downsize.
However, there is a specific rule that allows some property owners to rent out their home and avoid CGT. This is called the six-year rule.
What is the six-year rule?
The Australian Taxation Office explains that the six year rule allows you to treat a dwelling as your main residence for up to six years if it is used to bring in income. This means you wouldn’t have to pay CGT if you sold.
It also means that, if you don’t use it to bring in money, you can hold onto the property indefinitely without paying a tax on your profits. This could be the case if you decide to hold onto it as a holiday home.
What’s the catch?
There are some caveats to the rule. Firstly, you can’t treat another property as your official main residence for this same time period – unless you happen to be moving from one home to another, in which case the rules are slightly more flexible for this period of time.
You also need to ensure the home was considered your primary place of residence when you initially bought it. It can’t have been an investment property to start with.
Why is the rule in place?
There are many reasons you may not be living in your home for a stretch of time, which is why this rule has been created - to ensure home owners don’t get caught up in paying tax. It also means you can make some additional money from your own home for a period of time without triggering CGT.
The six year rule allows you to move out of your residence, rent somewhere else and rent out your former home, and then sell it before the six-year period is up without having to pay CGT. You can also move back in and rent it out in separate periods, provided the combined period does not add up to more than six years.
What if I rent it out for more than six years?
If you earn income from the property for more than six years, anything over the six years will be apportioned to work out how much tax is owing. This will divide the amount of time over and above the six years into the time of full ownership and will use this figure to separate out a portion of the profits that is applicable to CGT. The value of the property when you first started using it to earn income (based on comparative market value at the time) is used to determine the gains after this point.
The six-year rule re-sets each time you move back into the home for a period, provided each absence is less than six years.
As with all tax-related factors, it’s worthwhile speaking to your investment team and your accountant before making any major decisions. These rules apply to homes used to produce income after 1996. Always seek independent advice to maximise your investments.