How to Reduce Capital Gains Tax While You Are Away.
For many people, the single biggest asset they will own is the family home. Luckily, the Main Residence Exemption means Capital Gains Tax is not payable upon sale of this asset, under most circumstances. However, if you leave the property for an extended period of time, or you rent the property out, you may only be eligible for a partial CGT exemption. But the good news is there are two rules which can be applied to help to reduce the net Capital Gain – the Temporary Absence Rule and the Market Value Rule.
Temporary Absence Rule:
The Temporary Absence Rule allows you to leave your main residence for a period and still treat the property as your main residence while you are away – so you can still claim the main residence capital gains tax (CGT) exemption.
So, if you are living in your house and treating it as your Main Residence for tax purposes, then you decide to move out (e.g. to go on an extended overseas holiday, to live in another property, or to rent this property out), so long as you do not claim another property as your main residence, you can apply this rule.
Example of the Temporary Absence Rule:
Rod buys a house in April 2000 for $300,000, and he moves out in April 2011 and the property had a market value of $500,000 at that time. If he rents the property for 5 years, and then sells it in April 2016 for $600,000, at first glance Rod has made a $300,000 capital gain. However, he can apply the Temporary Absence Rule, and get a full CGT exemption because he had rented the house out for 5 years, which is within the six years of the Temporary Absence Rule.
If Rod rents the house out for more than six years, the he will only qualify for a partial Capital Gain exemption. However, he can make use of the Temporary Absence Rule AND the Market Value Rule, to reduce the CGT payable.
Market Value Rule:
This rule applies if you buy a home and start living in it (from the outset it is your main residence), but some time down the track you decide to rent it out. By renting out the property you are using it for “income producing purposes” which attracts capital gains tax upon the sale of this asset.
When you apply the Market Value Rule, the Capital Gain is calculated using the marketing value of the property at the time you started using the property for income producing purposes - rather than from the purchase price of the property.
Example TWO: Rod buys a house in April 2000 for $300,00, and he moves out and rents it out in April 2008 and the property had a market value of $400,000 at that time, and then sells it in April 2016 for $600,000. Applying the Market Value Rule gives us a Capital Gain of $200,000.
He can also apply the Six Year Exemption Rule, to six of the eight years he rented out the property. This will be calculated as follows:
6 years exempt / 8 years rented x $200,000 Capital Gain = $150,000 Capital Gain disregarded leaving a Net Capital Gain of $50,000. So effectively Rod will on pay Capital Gains Tax on $50,000.
As you can see considerable savings are available through applying these rules which is great news for anyone wanting to reduce CGT and have more flexibility with renting out their main residence for extended periods of time. If you would like to know more about how these rules can benefit you and your particular situation don’t hesitate to get in touch with us. ______
*the first income producing period must be after the 20th August 1996.
*The property needs to be held for 12 months from that first income producing time.
*It also worth noting that the Temporary Absence Rule can be “reset” by you moving back into the property, then moving out again. Additionally, it does not matter if this property was your “main residence” from the outset or not.