Note: While we’ve made every effort to make the below article accurate, we’re not tax professionals. Hence, please don’t rely solely on this article before making any decisions and seek the advice of a tax and finance professional.
If your home is your main residence, and you don't use it as a business or let it out, then it is likely that you won't be liable to pay tax on any profit you make. You pay tax on your wages, you pay tax on your investments, you pay tax on your business — but your home is in theory tax free, even if you make a profit when you sell it. (That's only fair, after all — you need somewhere to live, and if you're selling up, you're probably reusing the proceeds to buy another place.)
But — isn't it annoying how there's always a 'but' involved? — there are strict rules guarding this exemption, and it's distressingly easy to fall foul of the tax office if you don't pay proper attention to the regulations. (That's one reason you should consider seeking professional advice before you put your home on the market.)
There are several different ways you can lose your exemption —
- if you've let your house out at a time when you were living elsewhere,
- if you use part of your property for a business,
- or if you've been 'flipping' for profit.
There's more detail on the tax office website, which you should definitely check out. In these cases the profit on selling your home could be taxable — it will be included in your taxable income for the year and you'll pay tax at your top marginal rate. That could really hurt, if you're not careful.
In many cases, though, the tax office has made specific provisions to help you out, and we'll describe them in this article. But remember, while we can show you the basics, we can't give you tax or financial advice. Everyone's situation will be different, so if you have any doubts about your tax position, it's best to find a finance or tax professional who can advise you.
Not Eligible for an Exemption?
Even if you have to pay tax on selling your home, you can legally minimise your capital gains tax liability. First of all, make sure you claim all the costs you can against the proceeds of the sale. If you've made improvements, you can deduct the cost of the works; make sure you keep all your receipts, right down to the extra tin of paint that had to be bought just to finish the corner of the living room. You can also claim for the costs of purchase and sale, such as legal expenses and commissions, any bank fees involved, and so on.
In fact, even if you're expecting to use the main residence exemption, you should keep all your receipts. Things do change - you have to move in a hurry, or you may decide to buy another property and let your old home out rather than sell it. You might even look at how much prices have risen and decide to flip the house you've done so much work on even though you'd really meant to settle down. In all those cases, keeping your receipts and being able to claim for your outlay will help you pay less tax.
Studying or Working Away from Home?
If you let your home out at some point while you were working elsewhere - perhaps on secondment, or to study overseas - there are specific rules that apply and that will reduce your tax bill. Temporary absence rules (Here's a good guide and a tax office explanation with lots of case studies) give you up to six years' exemption (the 'six years rule) while you're living elsewhere, even if you let the property out. If you don't use it to produce income, you can continue the exemption indefinitely. If you move back in at any point, the clock is reset and if you let it out again, you'll get another six years' exemption.
However, there's a glitch; if you're not a tax resident of Australia at the time you sell, you'll pay tax on your capital gains, though if you return to the country and then sell the property, you will probably remain exempt from capital gain tax. That could make it more attractive to sell straight away if there's any chance you might settle down abroad, rather than keep the property as an investment.
Buying a New Home Before you Sell the Old One?
If you've seen your dream home but can't sell the one you have, things become complicated. Which is your main residence? Which one gets the capital gains tax exemption?
Fortunately, the Tax Office gives you an overlap period of six months. The old home needs to have been your main residence for at least three months in the twelve months before you sold it, and you must not have let it out at any time in that period. If that's the case, you'll pay no tax.
If it takes you longer than six months to sell, both homes are only exempt for the last six months before the sale. You have to choose whether to claim the exemption on the home you're selling, or to transfer it to the new one. If you want your new home to be exempt from the start, then you'll pay pro rata tax on the property you're selling. (Calculate the non-exempt days as a percentage of the total days you owned the property, and apply that percentage to the capital gain.)
Properties Held as Investments
Investment properties are treated differently. There's no main residence exemption, of course, but if you hold a property for more than 12 months you'll get a 50% discount - you calculate your tax using 50% of the net gain, instead of the whole gain. (If you planned to sell in your eleventh month of ownership, it's worth deferring the contract by a few weeks - your tax saving could be well worth sweetening the deal for a later settlement!)
Calculating your gain for tax purposes is tricky; if you have claimed capital works or decline in value deductions while you've owned the property, those have to be added back. On the other hand you can claim any capital expenses which were incurred buying or selling the property, or which were necessary to make the property suitable for rental (not while it was rented out). As always, make sure you keep every single receipt, however small, as evidence of your outgoings.
If you make a loss, you can carry it forward to set against capital gains in future years. That can be particularly useful for multi-property portfolios. If you make a loss on your main residence, on the other hand, that's tough; you can't claim your loss against rental properties.
Working from Home?
There are also different provisions if you work from home. If you do so on an occasional basis, and your main place of business is elsewhere, you'll still get the main residence exemption — so don't worry if, for instance, you're a road warrior four and a half days a week and spend the other half a day getting your paperwork straight in your home office, or if you have a retail outlet but you do your accounts and purchasing from home. Even if you have a dedicated workspace set aside, and even if you claim tax deductions for your equipment, phone and utilities, your exemption won't be affected.
Things get more complicated if your home is also your main place of business. Part of your capital gain will have the main residence exemption applied, but part of it will be taxed. The exact proportion will depend on a number of things; how much of your total floor area is given over to the business, and the length of time you have used it, compared to the length of time you've owned your home. So, for instance, if you used 20% of the floorspace to run your PR business, but only for half the time you've lived in the property, you'd be liable for capital gains tax on 20% x 50% of your profit — that is, 10% of the total. And you could also apply the 50% capital gains discount, if you've owned the property for more than 12 months, so you would only end up liable for tax on 5% of your total gains.
Many people think they can make a great tax-free income by flipping. Think again! The Tax Office is on to this scheme, and if it's obvious that you bought the property just to do it up and sell it on, you'll pay tax on your profit, even if you were living there. If you move home three times in four years, each time buying cheap and selling dear; if your house sales are your main source of income; or if your loan documents show you'll need to sell in the short term, all of these are a clue to the ATO that you're flipping.
If you genuinely bought your home as a main residence, or bought a long-term rental property, and simply sold earlier than you'd originally planned, you should still be able to argue that you're not a flipper. For instance, you might have needed to move for work, you might have received an unexpectedly high offer for the property, or you may have needed to raise money - all valid reasons why you might have changed your plan. If you're successful in pleading your case, you'll get the main residence exemption, or you can claim your 12-month 50% discount — barred to flippers! But remember, the Tax Office will track down cheaters — you probably won't be able to do it twice.
If you're thinking of selling a property and think you'll have to pay capital gains tax, the Tax Office provides a handy exemption calculator which will work out your maximum exemption. It's a good idea, particularly if cash flow could be tight, for instance if you're getting divorced and selling a former marital home to pay for your new accommodation, to work out how much tax you might end up paying well in advance.
Your Best Strategies — A Summary
If you want to ensure you’re not caught out on capital gains tax when selling your home, then your best strategies are simple (and all 100% legal).
- Live in it! And claim your total exemption from tax on your main residence.
- If it's an investment, hold it for 12 months to get a 50% exemption.
- Use the 'six year rule' if you're going to rent your home out — but make sure you are an Australian tax resident when you sell.
- Move back into your home between tenancies and you can enjoy a second six years' exemption while you let it out.
- If you have a choice of two properties you own, choose the one with the highest capital gain as your main residence and pay tax on the one that will make less money.
- Think carefully if you're moving abroad to work or study — if you sell your home while you're away, you won't get any exemption at all.
- Reduce your total taxable income to reduce your overall tax bill — take a sabbatical, or contribute to a Self Managed Super Fund.
Don't Worry, be Happy
Ninety percent of home sellers probably won't have a single problem with tax — they'll claim their main residence exemption and that will be the end of it. But just in case you're one of the exceptions, it makes sense to know the rules, itemise your costs, keep all your receipts, and be prepared to do the calculations.
And seek advice from a tax professional. Although we've tried to set out the basics in this article, tax is a tricky field with complex rules, which often change or are refined over time.
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