The 6-year property capital gain tax rule

Property investing is already tiring and daunting, then there is this 6-year CGT rule everyone tells me about. But how does it really work? Here I will take a quick dive into a common misconception of the 6-year CGT rule in Australia, using it as a case study.

Recently I was talking with a friend who told me he had sold his property because of capital gains tax concerns. I immediately frowned upon his decision, had he had the conversation with me earlier he could still be earning rent and enjoying more capital growth from his property. He had heard of the 6-year CGT rule from a friend and worried that because his 6 year theshold is near it's end, he would have to pay capital gains tax on all his gains.

CGT

The misconception

You can rent out your main residence for up to six years with out incurring capital gains tax. However, if you sell after 6 years, you are liable for capital gains.

The above statement, though correct is misunderstood. Let me run through an example of a common misconception:

Date Event
2000 John buys his main residence for $500,000.
2001 John moves to live with his girlfriend and rents out his property.
2008 John sells his property for 1,000,000.

In the above example, a common misconception is to think you are liable for a capital gains tax bill of $250,000 to be added to your taxable income. Though not entirely untrue, it does not have to end up like this.

The right thing to do

Date Event
2000 John buys his main residence for $500,000.
2001 John moves to live with his girlfriend and rents out his property.
2007 John arranged for property valuation to be done. The property was valued at $850,000.
2008 John sells his property for 1,000,000.

The ATO* states that you are allowed to use your main residence to produce income for up to 6 years immediately after you cease living in it as long as you do not treat another property as your main residence. In 2007, if John wishes to keep the property, he has a couple of options:

  • Move back into the property (for a minimum of up to 6 months for the main residency rule to "reset" for another 6 years)
  • Get a property valuation done

If moving back into the property is not an option, John should consider getting a professional property appraisal done. When he sells the property in 2008, he will only be liable for the capital gains after the 6 year mark. In additional to the capital gains concession for holding the property for more than 1 year, he will be liable for a capital tax bill of $150,000 * 50% = $75,000 to be added to his taxable income.

 

* https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Real-estate/Treating-a-dwelling-as-your-main-residence-after-you-move-out/