Source: By Paul
Clitheroe, The Sunday Telegraph - 23/10/05
FOR most of us, the family home is our biggest investment.
Normally, any capital gain you make when you sell what is
technically called your principal place of residence is
tax-free.
But this isn't always the case, and there are also potential
benefits if you understand the capital gains tax (CGT)
rules.
Let's say you buy a property, then rent it out to help pay
the mortgage in the early years.
If you owned the property for eight years and rented it out
for four of those years, CGT would apply to half the capital
gain if you sold it at the end of the eighth year.
There would be a 50 per cent discount on the CGT because you
owned the home for more than 12 months, but the bottom line
is that the government would share in your upside.
The situation would be very different, however, if you lived
in the home for at least six months after you bought it.
If you then rented it out for the next four years, moved
back in again, then sold it three and half years later, no
capital gains tax would apply.
This assumes you don't have another property that you are
claiming as your principal place of residence during the
four years it was rented.
You also need to have genuinely lived in the home initially,
not just dropped around to pick up a token amount of mail.
The different result is due to the six-year rule, as it is
commonly known. This rule was developed originally to help
diplomats who went on overseas assignments, but is now more
widely applied.
It allows you to rent out a property for as long as six
years and still claim it as your principal place of
residence. If you lived in the home first, you don't lose
the CGT exemption.
Interestingly, where you own more than one home you have the
flexibility to decide which one is your principal place of
residence.
Say you bought a second home and decided to keep the home
you were previously living in to rent out.
If, five years down the track, the first home was sold and
made a significant capital gain, you can elect to claim the
first home as your principal place of residence. If you did,
you wouldn't have to pay CGT on this sale.
You would have decided that the second home has less
potential for capital growth, as CGT would be paid on that
property when it was sold.
The CGT would apply to the period where you chose to make
the first property your principal place of residence. In
other words, if you sold the second property five years
after you sold the first one, you would pay CGT on half the
gain.
This is because for half the period you owned the property,
it was not your principal place of residence, even though
you lived in it. The CGT discount would also apply.
If you do have to pay CGT on a property when it is sold,
remember to add to the cost base any renovations and other
capital expenses that were not tax deductible but that added
value to the home. A higher cost base reduces the CGT you
pay.
