Written By: Anthony J Cordato, Solicitor
Two thirds of Australians don’t need to travel to Bermuda or Switzerland to stay in a tax haven. That’s because they live in one – it’s called the family home.
In this article we explore the reasons why the owner-occupied family home is tax free, and how to keep it that way. All of the comments made are generalisations. Tax law is technical, and you need specific advice if you plan to act upon a suggestion made in this article.
What taxes might apply to the family home?
Three main taxes apply to the family home –
1. Capital Gains Tax (CGT) – is paid on the profit made when a property is sold. Normally, the family home is exempt. If you don’t keep the family home exempt, then the capital gain – the sale price less the purchase price less capital expenses - will be added to your normal income. The tax payable will depend on what other income is received in the year you sell.
Illustration: if your property is sold and the capital gain is $100,000, assuming that your other income is $85,000, your income will increase to become $185,000 and the extra tax will be $39,309.99.
2. Income Tax – is paid on rent. Owner occupiers who rent out a room or a granny flat need to add the rent to their income, and pay tax on it.
Illustration: if a granny flat is rented for $300 per week, then $15,600 (less expenses) is added.
3. Land Tax - is paid on the land value. Normally, the family home is exempt. If you don’t keep the family home exempt, then land tax is payable annually calculated upon the land value. It is just the land value, not the market value of the land plus the home, which is liable for land tax.
Illustration: if the land value exceeds the land tax value threshold ($549,000 in NSW this year) then land tax of either 1.6% or 2% is payable annually on the excess value. Each State levies land tax in a similar way.
The Capital Gains Tax exemption for the Main Residence
The Australian Taxation Office calls the family home the ‘main residence’. Any capital gain / profit received on its sale will be tax free provided these requirements are mostly satisfied:
• you and your family live in it
• your personal belongings are in it
• it's the address your mail is delivered to
• it's your address on the electoral roll, and
• services such as gas and power are connected
The following rules apply to the main residence exemption:
Rules for moving in and moving out
• You must move in as soon practicable after purchasing your family home. If you are building a new home or renovating, you must move in as soon as practicable after it is ready to occupy.
A common mistake is to buy, rent out the home for a while, and move in later on. When this happens the increase in value until you move in is subject to capital gains tax.
• You may move out and rent the family home for up to six years without losing the capital gains tax exemption, so long as you do not purchase another family home in the meantime. Before the six year period ends, you have the choice of either selling (if so, the sale proceeds will be tax free) or moving back into the family home (which will re-start the six year period).
• You may move out and leave the main residence vacant or allow a family member to live in it rent free, and it will remain capital gains tax exempt indefinitely.
• You have a crossover period of six months if you purchase a new home first and then sell your old home. During that period you can call both homes your main residence.
Rules for ownership
• If your name is recorded as an owner on the property title, and if you occupy the home as your main residence, then the capital gains tax exemption applies to you. The exemption applies only if the home is in a personal name. If the family home is in the name of a company or a trust, you may have asset protection, but do not have capital gains tax exemption.
• If you own a family home and a holiday home jointly with your spouse, you cannot claim to live in both homes for capital gains tax purposes. The capital gains tax exemption applies only to the home you live in.
• If you inherit a family home there is a time limit of two years from the date of death to sell it. Otherwise, capital gains tax will be payable on the increase in value from the date of death.
The two year time limit does not apply if the inherited home was purchased on or before 20 September 1985. These homes are ‘grandfathered’ and will remain tax free whenever they are sold by the beneficiary who inherits the home.
Rules for renovation and subdivision
• If you buy a house to renovate or build a house for a profit, when you sell, the whole of the profit may be treated either as ordinary income or as a capital gain. That is, the main residence exemption from capital gains tax might not be available even if you live in the house.
• If you subdivide land with a family home built upon it, the profit on sale of the family home will be capital gains tax exempt while the profit on sale of the subdivided land will be treated either as ordinary income (if you bought to subdivide) or as a capital gain (if not).
General Rules for capital gains
• If you own a property for more than 12 months, then only one half of the capital gain is added to your income (this is known as the 50% capital gains tax discount) in the year you sell.
• If you purchased the property before 5 February 1999, you can choose to apply CPI to the base value for CGT instead of the 50% capital gains tax discount method, when you sell.
• If you purchased on or before 20 September 1985 – whether lived in or rented, the capital gain is tax free! Why that date? Capital gains tax was introduced on that date.
• If you sell a property, the date a contract for the sale of the property becomes unconditional is the date the capital gain is made, not the date that the sale proceeds are received.
Where the Family Home is used to produce income
A home office, a granny flat and a room or whole home rented short-term produces taxable income. But short-term rentals result in a partial loss of the capital gains tax exemption.
• A home office use means part of the home is used exclusively as a place of business and is not readily adapted for private use. Examples are a doctor’s surgery, a consultancy practice, a photographic studio, which members of the public can visit.
The positive is that interest paid on the home loan may be deducted from the business income for tax purposes, in the proportion that the floor area of the home office bears to the floor area of the home. The negative is that the capital gains tax exemption is partially lost in the same proportion for the period in which that part of the home is used as a home office.
• Permanently renting a granny flat, separate flat or rooms in a house which is owner-occupied is similar to having a home office in terms of rent being taxable income and a proportion of interest and utilities such as electricity and rates and insurance being tax deductions. Again, the capital gain is calculated on the proportion of the house rented, for the period of time it was rented. On its website, the ATO notes that payments received from a family member for board or lodging are considered to be domestic arrangements and are not rental income.
• The ATO treats renting a family home or rooms short-term through a sharing economy website or app, like Airbnb, Stayz or a rental agent, as being the same as permanent renting both for income tax purposes and for capital gains tax purposes. The ATO requires you to keep records of all income earned and declare it in your income tax return, and to keep records of expenses you claim as deductions. The capital gains tax exemption is partially lost proportionally based on the floor area rented out, and the length of time it was rented (or was available for rent).
The Land Tax exemption for the Principal Place of Residence
Like the capital gains tax exemption, the land tax exemption applies to the family home, which is called the ‘principal place of residence’. These are some of the rules:
• There can only be one principal place of residence, within or outside of Australia. The residence must have a kitchen, bathroom and toilet facilities.
• The exemption applies only if an owner uses and occupies the residence during the land tax year.
• If not all of the owners occupy the residence, so long as one owner does, then their occupation will exempt the whole property from land tax.
• The exemption applies although part is used as a home office, or a garden apartment or separate flat or rooms (no more than two) are rented. The exemption also applies to short-term lettings such as bed and breakfast accommodation where an owner lives on site.
• A crossover period of 6 months applies when moving houses, during which two residences can be treated as principal places of residence.
• A principal place of residence will retain its exemption for up to 6 years after the owner occupier has moved out, provided they do not own another principal place of residence.
Be careful of the Centrelink assets test
The sale of the family home can drastically affect the entitlement to the aged care pension and the viability supplement for aged care. These are some of the rules:
• The family home is exempt from inclusion in the assets test for age pensions, no matter what its value. A single home owner can hold up to $552,000 in assets (apart from the home) before the aged pension cuts out, and a home-owning couple can hold up to $830,000 in assets (apart from the home). If your assets exceed these amounts, you do not have pension entitlements.
• For non-home owners, the assets test limit is $230,000 higher. It is $755,000 for a single person and $1,033,000 for a couple. This means that if the family home is worth more than $203,000, it is better to keep owning it, not selling it to free up cash.
• If the family home is sold and the proceeds of sale are not used to buy a new family home or aged care accommodation within 12 months, then the proceeds of sale are added to the assets. Aged care accommodation units and bonds are treated as a family home and are not counted in the assets test.
• If the family home is sold to downsize and free up cash, the surplus proceeds of sale is added to the assets for the pension assets test.
• It is not possible to give away the surplus to relatives so as to the aged pension. Centrelink will allow only up to $10,000 per year (and a total of up to $30,000 over 5 years) to count as a reduction in assets. But Centrelink does not prohibit proceeds of sale to be used to repay personal debt, for home improvements, or to pay for personal holidays such as retirement cruises.
• Reverse mortgages can be attractive as an alternative to sale, where small amounts of money are needed, because it enables retirees to raise funds against the equity in their home without selling it.
Its tax exempt status makes the family home in Australia very valuable. Coupled with the fact that there are no inheritance taxes in Australia, it makes perfect sense for Australians to buy a family home to live in and remain living in it as long as possible.
For more property information, visit my website www.propertyinvestmentlawyer.com.au