How to avoid capital gains tax on rental properties: common strategies for investors. Capital Gains Tax (CGT) is a key consideration for property investors. But what exactly is it, and how can you reduce or avoid the capital gains tax you need to pay? The good news is, CGT is less complicated than you might think. There is even a 50% discount offered to eligible investors who have held an asset for at least a year. There are a few little-known exemptions - including the six year and six month rules - potentially saving property investors thousands by avoiding capital gains tax. Two other routes to save on CGT include improving your cost base or qualifying for an affordable housing CGT discount.
A capital gain is the profit made when selling assets like property or shares. A capital loss is when you dispose of an asset and lose money. A capital gain - or loss - can be declared on your tax return each year. If you’ve made a gain, you may need to pay Capital Gains Tax (CGT). The amount of CGT payable depends on your tax bracket and how long you held the asset. There is a 50% CGT discount for Australian residents for tax purposes who have held an asset for at least 12 months. For example, if Bob sells his Perth investment property initially purchased at $450,000 (including stamp duty and other fees) for $700,000 - he has made a $250,000 capital gain. But, having held the asset for more than 12 months, he is eligible for a 50% CGT discount. He therefore only needs to declare a $125,000 capital gain on his tax return.
Family homes or your Principal Place of Residence are generally exempt from CGT, provided they meet the main residence exemption. Vacant blocks of land cannot count as a PPOR. There are a few criteria for your home to be considered your PPOR. It needs to be where you and your family have resided for the duration of ownership and where your personal belongings are. It also needs to have utilities like gas and electricity connected and be registered as your postal and electoral roll addresses. A PPOR is exempt from CGT, provided it has been lived in by your family for the duration you have owned it, and not been used to produce income (i.e, rented out or used to run a business). A PPOR on land of more than 2 hectares (4.9 acres) does not qualify for CGT exemptions.
Two key CGT exemptions include the six month rule and six year rule. These may apply to landlords or property investors in certain situations, potentially saving thousands of dollars or avoiding CGT entirely. Although, it is important to consult an expert before making decisions around these exemptions.
The six year rule allows you to treat your investment property as a PPOR—even while it is being rented out—for up to six years, provided it is used to make income during that period. Hence, you could sell your rental within the six-year period and be exempt from capital gains tax as you would with your principal place of residence. This is an attractive incentive for homeowners who cannot reside in their homes for a period of time seeking to make rental income. They can rent it out for up to six years without needing to eventually pay CGT when selling the property. The six year rule is counted per absence. The rule ‘resets’ each time you move back into the property and treat it as your main residence. For example, Jane initially rented out her home for five years between 2012 and 2017. She decided to move back in 2017 until 2018, and rented it out again for four years between 2018 and 2022. When Jane sells the property in 2023, she is eligible for a CGT exemption as the six year rule period reset when she moved back in; potentially saving her thousands.
Under the six month rule, the Australian Taxation Office allows you to hold two PPORs for up to six months. Hence, if you acquire a new home before disposing of your current one, there is effectively a six-month grace period where your old home is exempt from CGT. This rule is applicable pending the following criteria The house being disposed of was your main residence for at least 3 continuous months in the 12 months before you dispose of it You did not use your home to produce income in the 12 months when it was not your main residence The new home will become your PPOR
If you do not qualify for the above concessions, it is still possible to reduce the amount of CGT payable on your investment property.
If your rental was used to provide affordable housing for at least three years, you can reduce your capital gains tax by a further 10%, up to 60% in total including the 50% discount. The affordable housing CGT discount is offered to landlords who rent their house through a community housing provider (CHP) for at least 3 years after 1 January 2018. Under this scheme, a registered CHP will become your property manager who will find eligible tenants and determine the rent charged. The rent earned off your investment may be lower than market rates, but can potentially help people facing housing unaffordability or stress. The tax incentive was introduced in 2018 and aims to boost investment in affordable housing. Other criteria for the discount apply.
A property’s cost base is the purchase price plus any costs associated with buying, owning, and selling the property. It might include loan repayments, stamp duty, property management costs, council rates, or renovations. Thinking about financing renovations for your investment property? Speak to a UNO broker today.As a capital gain is calculated by subtracting the asset’s sale price from its cost base, increasing your cost base could potentially reduce CGT payable. In the above video, UNO Founder Vincent Turner says visually appealing yet useful renovations like remodeling can potentially increase your investment property's cost base. Renovating is one popular route to increase one’s cost base. Whether giving your kitchen a facelift or modernising a whole floor plan, it may reduce the CGT you pay later. Read more: A guide to renovating for profit
The ATO requires a capital gains tax property evaluation to determine the capital gain made on an investment property.
Valuations can determine the cost base, often retrospectively, which can be useful to increase your investment property’s cost base, potentially reducing CGT.
Accurate valuations can be complex but are crucial to determine how much CGT you need to pay.
Disclaimer: Information in this article is general in nature and does not constitute personal financial advice. You should always seek independent professional advice that considers your personal needs before making financial decisions.Sourceswww.ato.gov.au/Individuals/Capital-gains-tax/Property-and-capital-gains-tax/CGT-discount-for-affordable-housing/www.ato.gov.au/individuals/capital-gains-tax/calculating-your-cgt/cost-base-of-assets/treasury.gov.au/sites/default/files/2019-03/Boosting-affordable-housing-for-Australians-through-incentivising-investment.pdfwww.ato.gov.au/individuals/capital-gains-tax/property-and-capital-gains-tax/your-main-residence-(home)/treating-former-home-as-main-residence/https://www.ato.gov.au/individuals/capital-gains-tax/property-and-capital-gains-tax/your-main-residence-(home)/