How to pay no capital gains tax when selling your rental property

‍What is capital gains tax (CGT)? 

Capital gains tax (CGT) is the tax you pay on profits from disposing of assets, including investments, such as property, shares, and crypto assets. If you dispose of assets, you may need to report capital gains or losses in your income tax return.

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How does CGT apply to the disposal of your rental property?

You may make a capital gain or loss when you sell or dispose of a rental property. A capital gain or loss is the difference between what it costs you to obtain and improve the property (the cost base) and the amount you receive when you dispose of it.

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For example, you bought a residential property for a purchase price of $750,000. In addition, the following costs were incurred: stamp duty and legal fees of $4,000 and fence construction expenses of $6,000. The property was sold for $900,000 during this financial year. 

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Your capital gain will be 

$900,000 - ($750,000 + $4,000 + $6,000) = $140,000

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‍If you make a:

• net capital gain in an income year, you'll generally be liable for capital gains tax (CGT)
• net capital loss, you can carry it forward and deduct it from your capital gains in later years.

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How to pay NO CGT when disposing of your rental property?

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By applying the CGT main residence exemption to your rental property, you can avoid paying CGT on your capital gains.

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Your main residence (your home) is generally exempt from CGT. Usually, a property stops being your main residence when you stop living in it. However, for CGT purposes, you can continue treating the property as your main residence: 

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• for up to 6 years if you used it to produce income, such as rent (sometimes called the '6-year rule')
• indefinitely if you didn't use it to produce income

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To apply the CGT main residence exemption to your rental property, it must have been your main residence first.

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Note that you cannot treat any other property as your main residence (except for up to 6 months if you are moving house) if you apply the exemption to your rental property. Also, if you rented out your home before you lived in it, the main residence exemption doesn't apply to the period you rented it out to begin with.

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What is the 6-year rule?

If you made your former home a rental property, you can treat it as your main residence for up to 6 years after you stop living in it. The 6-year period applies to each period of your absence. A period of absence stops when you either stop renting your home and move back in or leave it vacant.

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For example, You bought a house in Wollongong in April 2022. After a month, you bought and moved into a new house in Sydney but kept owning your Wollongong house for 10 years as follows:

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• rented the house out for 3 years
• left it vacant for 2 years
• rented it out again for 3 years
• left it vacant again for 2 years

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You sold your Wollongong house during the 2024FY and produced a capital gain of $140,000. 

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In this case, you can treat your house in Wollongong as your main residence and disregard your CGT on the sale of the house in your 2024FY tax return. Although you owned the house for 10 years after you moved out, the total period producing income as a rental property was 6 years, so that 6-year rule applies. 

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CTK Accounting is a full-scope accounting firm based in Wollongong, servicing clients nationally.

For advice on Tax, BAS, GST, Bookkeeping, and Payroll issues visit us at ctkaccounting.com.au