Applying the Capital Gains Tax (CGT) main residence exemption
When you sell or otherwise dispose of an asset it is described as Capital Gains Tax (CGT) Event. This is the point at which you are deemed to have made a capital gain or loss. CGT is not a separate tax.
A capital gain or capital loss on an asset is the difference between what it cost you to acquire that asset and what you received when you dispose of it. Any net capital gains are added to your ordinary income and you are taxed on the total amount at the applicable marginal tax rate. Capital losses can not be deducted rather they are offset against current or future capital gains.
When an individual sells a property they may be eligible for a full or partial main residence exemption. This is dependent on whether the dwelling is their main residence or not. Your main Residence (your home) is generally exempt from capital gains tax. However, you may be eligible for a partial main residence exemption if you used any part of it to produce income during all or part of the period that you owned it.
6 Year Rule
Generally, if the dwelling is used to produce ordinary income, such as an investment property or holiday home than you are not eligible for the main residence exemption. However, if you originally lived in the dwelling and do not treat any other dwelling as your Principal Place of Residence (PPOR) ‘the 6 Year Rule’ may apply.
The ATO’s recently expanded data matching program has caused concerns for whether the main residence exemption is being incorrectly applied by some individuals in relation to the disposal of a dwelling, and therefore whether the correct amount is being disclosed in terms of capital gains in their tax returns.
To avoid a potential audit by the ATO you must ensure you are entitled to claim the main residence exemption. In instances when you are only eligible for a partial exemption you must ensure that you have applied it correctly.
There are two particular areas of focus for individuals in regards to applying the exemption correctly
- Incorrectly claiming a full exemption when the dwelling is used as a rental property or business premises
- Incorrectly claiming the full exemption for backyard developments or where the property is subdivided
If you incorrectly claim an exemption you may be liable for penalties imposed by the ATO in addition to being required to pay the correct tax. Hence, it is important to apply the exemptions correctly.
Here at the Quinn Group we can assist with any questions regarding your potential Capital Gains Tax liability or help if you have been notified of an impending audit in relation to your previously lodged income tax returns. Contact us on (02) 9223 9166 to discuss with one of our team of tax accountants or tax lawyers or fill out an online enquiry.