Capital gains tax on the home continues to baffle people. In a recent email a reader wondered about the position when a person moved into a new home, and rented out the original one. He asked if they can they nominate which is their principal place of residence, and also what address to put on their annual tax return.
It is correct that you can be absent from your residence and live in another home, you own, without losing the CGT exemption. If the property is being used to produce income then the period of absence is limited to 6 years, for the full exemption, though setting up home there again means another 6 years when you move out. For those who like history, the six years came about because that just happens to be the term for a politician in the Senate. This law enables politician to move to Canberra for six years without losing the CGT exemption on their home then come home for a while to fight an election then rent out their home for another six years.
If the property is not being used to produce income then period of time it can continue to be covered by your main residence exemption is infinite.
It gets a bit tricky when you move out of a residence, and start to live in another one and treat that as your new residence. The good news is, that you don’t need to elect which home is your principal residence, until you decide to sell one of them. This may be several years down the track. It is important to keep receipts for expenses relating to both properties to keep your options open. Anything to do with the property that has not otherwise been claimed as a tax deduction has potential such as interest, rates, repairs, insurance and improvements. But also consider every day expenses such as cleaning materials, light globes, lawn mower fuel etc.
Furthermore, if you do decide to treat the new home as your residence, you are only liable for CGT on the original home, on the gain, from the date you rented it out. This is why it’s important to get a valuation on that property when you move out of it. This resetting of the cost base to market value does not apply if you do not use it to produce income.
Let’s look at an example. You own a property, which is worth $600,000 when you move to a new residence which costs $800,000. In five years, the original property is worth $700,000 and the new residence is worth $1.2 million. There are no decisions to make until you are thinking about selling one. But let’s suppose you’ve decided to keep the rental property, because you are now downsizing to a retirement village.
After talking to your accountant, you will probably decide to nominate your present residence as your principal residence, leaving an unrealised capital gain on the original property on which no CGT will be payable until the property is sold.
The address for tax return purposes is the actual address of the place you are living in. That makes no difference to the CGT position but it is important that you retain evidence that you lived at both places at some time.
There is one exception to the rule which can be utilised by savvy investors. If a property is your principle residence at the date of death, any previous CGT liability can be avoided.
Suppose a person owned their own home, and also an investment property that was carrying a high unrealised capital gain. If they felt they were close to death, they could sell their current residence and move into the investment property and treat it as their own home. At date of their death, it would be their residence and would be deemed to be acquired by the beneficiaries at its market value at date of death. The property could then be sold by the beneficiaries CGT free within two years.