There are many reasons why homeowners may choose to change their current principal place of residence (PPOR) into an investment property. Whether it is because they are looking to upgrade to a larger – or perhaps downsize to a smaller – model, and wish to retain the original property as an investment, or alternatively they may have been geographically relocated due to work obligations, to name but a few. Regardless of the reason/s, there are numerous factors that homeowners, and subsequent investors, should be aware of when making the switch, especially in regards to tax.
The ‘principal place of residence’ can be defined as being the one place of residence that is, among the one or more places of residence of the person within and outside Australia, the principal place of residence of the person. Put simply, a person can only have 1 principal place of residence in the whole world.
‘Investment property’ is property, whether land or a building, part thereof of, or both, which is held by the owner (or by the lessee under a finance lease) to earn rentals or for capital appreciation or both.
The shifting of labels from principal place of residence to investment property occurs upon the homeowner’s physical relocation to the newly purchased property, that is, the new principal place of residence. Once this relocation has occurred and the first property is deemed to be an investment, there are several tax implications that the owner should to be aware of. Such tax issues include, but are not limited to, potential deductions as well as various possible Capital Gains Tax exemptions that the owner may eligible to claim, that are not able to be claimed on the principal place of residence.
Capital Gains Tax – Exemptions
Generally speaking, any capital gain or loss that is incurred as a result of disposing of, or selling, a principal place of residence is exempt from any Capital Gains Tax obligations.
However, there exists certain situations, whereby at the time of sale of the property, the owner may eligible for a partial Capital Gains Tax exemption. The 2 particular circumstances where the partial exemption is applied are: 1) the property was not used as the owner’s main residence for the entire period of ownership (although in some cases specific absences are allowed, this is discussed further below); and, 2) the property was used for income-producing purposes, while it was the taxpayer’s main residence and if a loan was taken out to purchase the property the taxpayer could have deducted the interest paid on that loan.
The example below demonstrates how the partial Capital Gains Tax exemption can be applied upon the disposal of an investment property that was once a principal place of residence.
A property was purchased on 1 July 2002 for $500,000. It was the owner’s principal place of residence until 30 June 2005 when it was then rented out until it as sold for $750,000 on 1 July 2007. The capital gain as a result of the sale was $250,000 and the owner is entitled to a partial tax exemption for the period in which they occupied the property. The exempt amount is calculated using the formula, amount of capital gain x number of years property was owner’s principal place of residence as a proportion of total years of ownership = amount of capital gain that is exempt.
In this instance the calculation is as follows:
$250,000 x 3yrs = $150,000
As $150,000 of the total capital gain is exempt from tax, the amount of taxable capital gain is $100,000. Additionally, as the property was owned for more than 12 months the owner is entitled to a further 50 percent discount on the assessable amount, making the total capital gain amount that is assessable for tax purposes $50,000 upon the disposal of this property.
Capital Gains Tax – 6 year rule
As mentioned above, there are provisions that allow for an owner’s temporary absence from the principal place of residence which do not affect the owner’s eligibility for the full principal place of residence exemption; this is commonly referred to as the 6-year rule.
The 6-year rule provides that the property’s owner can be temporarily absent from the principal place of residence for up to a maximum of 6 years at a time, without losing the exemption, provided that no other property is treated as the principal place of residence during that period. The owner can use the property to produce assessable income during that time and reset the 6-year period each time they move back.
As a practical example: A property is owned and occupied by the owner for a period of 3 years. Following which, the owner is then posted overseas for work commitments and remains there for 4 years, during this time the owned property is rented out. The owner returns to the country and occupies their principal place of residence for a further 3 years until such time that they are again posted overseas, this time for a period of 4 years. Upon returning to the country a second time the owner then sells the property. In this case, there is no Capital Gains Tax payable upon the disposal of this property as the owner was never away from the property for more that 6 years at a time, and no other property was treated as the principal place of residence during this period.
There are some definitive factors that must be considered in order for the 6-year rule to apply. One of these is that you need to move from your principal place of residence for a good reason. Some examples of ‘good reasons’ include: accepting a new job interstate or overseas; staying with a sick relative long term; or, going on an extended holiday.
There are various other financial and tax implications to be considered when transferring a principal place of residence to an investment property. It is important to remember that each individual situation is different and has a range of influencing factors. When considering making any kind of significant financial investment or transfer it is important to seek the professional advice of a lawyer and/or accountant in order to ensure that you make the best possible choices for your situation.
Contact the legal and accounting professionals at The Quinn Group by calling 1300 QUINNS (784 667) or on +61 2 9223 9166 to make an appointment. Alternatively, click here to submit an online enquiry for advice regarding investment properties and tax obligations, including Capital Gains Tax.