Key Takeaways
- The six-year rule may allow a former home to continue being treated as a main residence for Capital Gains Tax (CGT) purposes for up to six years while it is used to produce income.
- The property needs to have qualified as the owner’s main residence before the continuing main residence rules can apply to a later absence.
- Choosing to treat a former home as a main residence during an absence can affect the CGT treatment available for another property during the same period.
- If the owner moves back in and re-establishes the property as their main residence, a later absence may potentially have a separate six-year period.
Keeping a former home and renting it out can create important tax considerations, particularly if the property is sold later. For homeowners turning a principal place of residence into an investment property, one consideration is whether Australia’s six-year rule could affect the Capital Gains Tax (CGT) treatment of a future sale.
The tax position can also sit alongside lending decisions. Speaking with mortgage brokers in Sydney may help homeowners understand how retaining a former residence could interact with their existing mortgage, borrowing capacity and finance for another property. Tax outcomes are separate from lending assessments and should be discussed with an appropriately qualified tax professional.
The six-year rule is not a blanket exemption for every former home that becomes a rental. Its application can depend on the property’s history, the timing and nature of an absence, whether another property is treated as a main residence and other individual circumstances.
What Is the Six-Year CGT Rule?
The six-year rule forms part of Australia’s CGT main residence provisions. According to the Australian Taxation Office (ATO), a person who stops living in their main residence and uses it to produce income may choose to continue treating it as their main residence for CGT purposes for up to six years.
The ATO six-year rule can therefore be relevant where a homeowner moves elsewhere but retains their former residence as a rental property.
The six-year limit relates to periods when the former home is used to produce income. If the former home is not used to produce income, the ATO indicates that it may be possible to continue treating it as the person’s main residence indefinitely during an absence, subject to the applicable requirements.
The choice to continue treating a former home as a main residence is relevant when the property is eventually disposed of. The ATO indicates that the choice is made when preparing the tax return for the income year in which the owner enters into the contract to dispose of the property.
When Could the Six-Year Rule Apply?
Whether the rule is available depends on the history and use of the property. Several circumstances can influence whether a full or partial main residence exemption may apply.
The property needs to have been your home first
The continuing main residence rules cannot ordinarily be used to cover a period before a property first became the owner’s main residence. A property purchased and rented out before the owner begins living in it can therefore have a different CGT history from a home occupied first and rented out later.
This distinction is particularly relevant when turning a principal place of residence into an investment property because its use before and after the change can affect how the main residence exemption is calculated.
Income-producing periods matter
Once a former home is used to produce rental income, the six-year limit can become relevant. An eligible former main residence may potentially continue to receive main residence treatment for up to six years of income-producing use during an absence.
The six years do not necessarily need to form one uninterrupted rental period. Depending on the circumstances, income-producing and non-income-producing periods during an absence can be treated differently when applying the continuing main residence rules.
Another main residence can affect the position
Choosing to continue treating a former home as a main residence can affect another property’s CGT treatment. A person ordinarily cannot treat another property as their main residence for the same period, although limited exceptions can apply, including an overlap of up to six months in qualifying circumstances when moving between homes.
This can be particularly relevant where a former home is retained as a rental while another property is purchased to live in. The eventual CGT outcome can depend on the timing, ownership and use of both properties.
How Does the Six-Year Rule Work in Practice?
Consider a homeowner who lives in a property as their main residence before moving elsewhere and renting it out. If the relevant requirements are met, they may choose to continue treating the former home as their main residence for CGT purposes for up to six years while it produces income.
If the property is sold within the applicable period, a full main residence exemption may potentially be available, depending on the owner’s circumstances, the property’s history and whether another property has been treated as their main residence during the same period.
What Happens After Six Years?
Selling a former home after six years does not necessarily make the entire capital gain taxable. Where an income-producing absence exceeds the available six-year period, the property can become subject to CGT for the period beyond that limit.
The eventual calculation can depend on factors including the property’s ownership and occupancy history, when it first produced income, its relevant cost base and the periods for which the main residence exemption is available.
If a former main residence is used to produce income continuously for longer than six years during one absence, the period beyond the six-year limit may therefore contribute to a taxable capital gain or loss. The precise outcome depends on the applicable CGT rules and individual circumstances.
What If You Move Back Into the Property?
Moving back into a former home can be significant when applying the absence rules. If the property genuinely becomes the owner’s main residence again, a later move-out may potentially begin a separate period of absence.
The six-year rule is therefore not necessarily a once-only allowance attached to the property. Separate absences may potentially have separate six-year limits where the relevant requirements are met and the property becomes the owner’s main residence again between those periods.
Leaving a property vacant is not necessarily the same as moving back in and re-establishing it as a main residence. Whether a property qualifies as a person’s main residence depends on the facts and circumstances.
Why a Property Valuation Can Matter
A separate CGT rule may become relevant when a property that was previously a main residence is first used to produce assessable income.
Where the ATO’s home-first-used-to-produce-income rule applies, the property is treated as having been acquired at its market value at the time it was first used to produce income for the purpose of calculating a later capital gain or loss.
The rule does not apply to every property changing from a home to a rental. Relevant conditions include when the property was acquired and first used to produce income, whether it would have qualified for a full main residence exemption immediately before that use, and whether a partial exemption would otherwise arise when the relevant CGT event occurs.
Where the rule applies, evidence of the property’s market value at the relevant date can be important for a later CGT calculation. The ATO recommends obtaining a professional market valuation. A suitably qualified tax professional can help determine whether the rule applies to a particular property.
How Can the Change Affect Property Finance?
Although the six-year rule concerns CGT, retaining a former home can also affect a homeowner’s lending position. The existing mortgage remains a financial commitment, while expected rental income may form part of a lender’s serviceability assessment for another property.
Homeowners considering investment property loan options may therefore need to consider how existing debt, rental income and proposed borrowing are assessed together. Lender policies can differ, including in how rental income and property-related expenses are treated.
Equity and borrowing capacity are different
A former home may contain equity that could potentially be accessed for another property purchase. However, available equity does not automatically mean additional borrowing will be approved.
Accessing equity usually creates further debt and remains subject to lender valuation, serviceability and credit requirements. Homeowners considering using existing home equity may therefore need to consider the resulting repayments and total debt alongside the amount potentially available.
The existing loan may warrant review
Changing the property’s use can also be an appropriate point to understand the existing mortgage arrangements. Depending on lender policy and the loan terms, a change from owner-occupied to investment use could affect classification, pricing or other conditions.
Considering reviewing your existing loan does not mean refinancing or changing lenders will necessarily be beneficial. A potential change can involve a new credit assessment, fees, costs and different loan terms.
Where another property purchase is planned, investment property finance considerations can also include how borrowing capacity, equity and existing debt interact when the former home is retained.
What Should You Review Before Renting Out Your Former Home?
Before retaining a former home as a rental, relevant tax and financial considerations may include:
- when the property became the owner’s main residence;
- when the owner moved out and the property began producing income;
- whether another property may be treated as a main residence;
- whether the first-use-to-produce-income rule could apply;
- the potential need for a market valuation;
- the existing mortgage and any proposed additional borrowing; and
- records that may be required if the property is eventually sold.
Keeping records of occupancy dates, income-producing periods, property transactions and relevant valuations may help establish the property’s history if a future CGT calculation is required.
The tax and lending considerations should also be viewed separately. The six-year rule concerns the potential CGT treatment of a former main residence; it does not determine whether loan interest is deductible, how a lender will assess borrowing capacity or whether retaining the property is financially suitable.
Conclusion
The six-year rule may allow a former main residence to continue receiving main residence treatment for CGT purposes for up to six years while it is used to produce income, provided the relevant requirements are met. The position can become more complex where another main residence is involved, the income-producing period exceeds six years or the owner moves back into the property.
For homeowners turning a principal place of residence into an investment property, keeping accurate records and understanding the potential tax and lending implications may help clarify the position before the property is rented or sold. CGT outcomes depend on individual circumstances and applicable tax law, so appropriately qualified tax advice may be useful before relying on the six-year rule.
This information is general in nature and does not constitute financial, investment, tax or legal advice. Capital Gains Tax treatment, main residence exemptions and the application of the six-year rule depend on individual circumstances and applicable tax legislation. Lending eligibility, borrowing capacity, loan features and approval outcomes depend on individual circumstances and lender policies and may change over time. Consider obtaining advice from appropriately qualified professionals before making financial, investment, tax or legal decisions.
Frequently Asked Questions (FAQs)
1. What is the six-year CGT rule?
The six-year rule may allow an eligible former main residence to continue being treated as the owner’s main residence for CGT purposes for up to six years while it is used to produce income. Whether it applies depends on the property’s history and the owner’s circumstances.
2. Does the six-year rule apply automatically?
No. Continuing main residence treatment involves a choice and depends on the relevant CGT requirements being satisfied. The ATO indicates that this choice is made when preparing the tax return for the income year in which the disposal contract is entered into.
3. Does the six-year period start when I move out?
Not necessarily. The six-year limit relates to periods during an absence when the former home is used to produce income. Periods when the property is not used to produce income can be treated differently under the continuing main residence rules.
4. What happens if I rent my former home for more than six years?
If an income-producing absence extends beyond the available six-year period, the property may become subject to CGT for the period beyond the limit. The eventual CGT calculation depends on the property’s ownership, occupancy and income-producing history and other applicable rules.
5. Can the six-year rule restart if I move back in?
Potentially. If the property genuinely becomes the owner’s main residence again, a later move-out may create a separate period of absence with another six-year limit for income-producing use, subject to the relevant requirements.
6. Can I use the six-year rule on two properties at the same time?
A person ordinarily cannot treat two properties as their main residence for the same period. Limited exceptions can apply, including an overlap of up to six months in qualifying circumstances when moving from one main residence to another.
7. Do I need a valuation when my former home becomes a rental?
A market valuation can become relevant where the ATO’s home-first-used-to-produce-income rule applies. Where that rule applies, the property’s market value when it was first used to produce income is used for the relevant CGT calculation, and the ATO recommends obtaining a professional market valuation.