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  • Using your home to produce income

    Your main residence (your home) is generally exempt from capital gains tax (CGT). However, you don't get the full main residence exemption if you use any part of the dwelling to produce income (such as renting out a room or running a business), and:

    • you acquired your dwelling on or after 20 September 1985
    • you would be allowed a deduction for interest (had you incurred it) on money borrowed to acquire the dwelling – this is the 'interest deductibility test'.

    To work out your capital gain you generally need to know your home's market value at the time you first used it to produce income.

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    The interest deductibility test

    The interest deductibility test applies regardless of whether you actually borrowed money to acquire your dwelling. You must apply it on the assumption that you did borrow money to acquire the dwelling.

    If you rent out part of your home, you would be entitled to deduct part of the interest if you had borrowed money to acquire the dwelling.

    If you run a business or professional practice in part of your home, you would be entitled to deduct part of the interest on money you borrowed to acquire the dwelling if:

    • part of the dwelling is set aside exclusively as a place of business and is clearly identifiable as such
    • that part of the home is not readily adaptable for private use, for example, a doctor's surgery located within the doctor's home.

    You would not be entitled to deduct any interest expenses if, for convenience, you use a home study to undertake work usually done at your place of work. Similarly, you would not be entitled to deduct interest expenses if you do paid child-minding at home (unless a special part of the home was set aside exclusively for that purpose). In these situations, you could still get a full main residence exemption.

    If you set aside and use part of your home exclusively as a place of business, you can't get a CGT exemption for that part of the dwelling by not claiming a deduction for interest on your home loan. Nor can you include interest in the cost base if you are entitled to a deduction but don't claim it.

    You can still get a full main residence exemption if someone else uses part of your home to produce income and you receive no income from that person.

    What proportion is exempt?

    The proportion of the capital gain or loss that is assessable is an amount that is reasonable having regard to the extent to which you would have been able to deduct the interest on money borrowed to acquire the home.

    In most cases, this is the proportion of the floor area of the home that is set aside to produce income and the period you use the home to produce income. This includes the period the dwelling is available (for example, advertised) for rent.

    Example: Renting out part of a home

    Thomas bought a house under a contract that settled on 1 July 1999 and sold it under a contract that settled on 30 June 2018. The house was his main residence for the entire time.

    Throughout the period Thomas owned the house, a tenant rented one bedroom, which represented 20% of the house. Both Thomas and the tenant used the living room, bathroom, laundry and kitchen, which represented 30% of the house. Only Thomas used the remainder of the house. Therefore, Thomas would be entitled to a 35% deduction for interest (if he incurred it) on money borrowed to acquire his house.

    Thomas made a capital gain of $400,000 when he sold the house. The following proportion of the gain is assessable:

    Capital gain × Percentage of floor area = Assessable portion

    That is:

    $400,000 × 35% = $140,000

    As Thomas entered into the contract to acquire the house before 21 September 1999 and entered into the contract to sell it after that time, and held it for at least 12 months, he can use either the indexation or discount method to calculate his capital gain.

    The 'home first used to produce income' rule is irrelevant because Thomas used the house to produce income from the date he purchased it.

    End of example

    See also:

    Example: Running a business in part of a home for part of the period of ownership

    Jana bought her house under a contract that settled on 1 January 1999 and sold it under a contract that settled on 31 December 2017. It was her main residence for the entire time.

    For half the period Jana owned the house, she used part of it to operate her photographic business. She modified the rooms for that purpose and they were no longer suitable for private and domestic use. They represented 25% of the total floor area of the house.

    Jana made a capital gain of $320,000 when she sold the house. The following proportion of the gain is assessable:

    'Capital gain' multiplied by 'Percentage of floor area not used as main residence' multiplied by 'Percentage of period of ownership that part of the house was not used as a main residence' equals 'Taxable portion'

    That is:

    $320,000 × 25% × 50% = $40,000

    As Jana entered into the contract to acquire the house before 21 September 1999 and entered into the contract to sell it after that time, and held it for at least 12 months, she can use either the indexation or discount method to calculate her capital gain.

    The 'home first used to produce income' rule is irrelevant because Jana used the house to produce income from the date she purchased it.

    End of example

    Value of home when first used to produce income

    If you start using your main residence to produce income after 20 August 1996, you're generally taken to have acquired it at the time you first used it for this purpose. This means when you sell the dwelling, you need to work out the capital gain or loss using its market value at the time you first used it to produce income. You don't have a choice.

    This rule applies if all of the following are true:

    • you acquired the dwelling on or after 20 September 1985
    • you first used the dwelling to produce income after 20 August 1996
    • when you sell the dwelling (or another CGT event happens to it), you would get only a partial CGT exemption because you used it to produce assessable income during the period you owned it
    • you would have been entitled to a full exemption if the sale or other CGT event happened to the dwelling immediately before you first used it to produce income.

    A similar rule applies if you inherit a dwelling that was the deceased’s main residence and you use it to produce income.

    If the ‘home first used to produce income’ rule applies and the period between when you first use the dwelling to produce income and the CGT event happening is less than 12 months, you can't use the CGT discount method. If you use your home to produce income from the time you acquire it, the rule doesn't affect you. If you choose to continue treating a dwelling as your main residence after you move out, and the dwelling is fully exempt, the ‘home first used to produce income’ rule does not apply.

    Example: Home becomes a rental property

    Erin bought a house in July 2000 for $280,000. The house was her main residence until she moved into a new house on 1 August 2003. On 2 August 2003, she began renting out the old house. At that time, the market value of the old house was $450,000.

    Erin did not want to treat the old house as her main residence under the ‘continuing main residence status after moving out’ rule as she wanted the new house to be treated as her main residence from the date she moved into it.

    On 14 April 2018, Erin sold the old house for $696,000. Erin is taken to have acquired the old house for $450,000 on 2 August 2003 and calculates her taxable capital gain to be $246,000.

    Because Erin is taken to have acquired the old house on 2 August 2003, and held it for more than 12 months, she can use the discount method to calculate her capital gain. As Erin has no capital losses she includes a capital gain of $123,000 ($246,000 × 50%) on her 2018 tax return.

    End of example

     

    Example: Part of home used to produce income

    Fatima bought a house in December 1991 for $200,000. It was her main residence. On 1 November 2016 she started to use 40% of the house for a consultancy business. At that time the market value of the house was $520,000.

    She decided to sell the house in August 2017 for $620,000. As Fatima was still living in the house and using part of it for business, she could not get a full exemption under the 'continuing main residence status after moving out' rule. She works out her assessable capital gain as follows:

    Percentage of use × (proceeds − cost base) = capital gain

    That is:

    40% × ($620,000 − $520,000) = $40,000

    Fatima is taken to have acquired the house on 1 November 2016, so she is taken to have owned it for less than 12 months and must use the 'other' method to calculate her capital gain.

    End of example

     

    Example: Dwelling used to produce income for more than six years

    Roya purchased an apartment in Australia for $180,000 under a contract that settled on 15 September 1994, and immediately started using the apartment as her main residence.

    On 29 September 1996 she moved overseas and rented out the apartment. At that time the market value of the apartment was $220,000.

    During the time she was overseas she did not acquire another dwelling. She returned to Australia in July 2017 and sold the apartment for $555,000, under a contract that settled on 29 September 2017. She incurred $15,000 in agent’s and solicitor’s costs.

    As Roya rented out the apartment, she can only treat it as her main residence during her absence for a maximum of six years; that is, for the period 29 September 1996 to 29 September 2002.

    Roya must treat the apartment as having been acquired on 29 September 1996 at the market value at that time, which was $220,000.

    Roya works out her assessable capital gain as follows:

    Capital proceeds − Cost base = Total capital gain

    That is:

    $555,000 − ($220,000 + $15,000) = $320,000

    Then:

    Non-main residence days
    5,479 (30 September 2002 to 29 September 2017)

    Ownership period days
    7,671 (29 September 1996 (new deemed acquisition date) to 29 September 2017)

    $320,000 × (5,479 days ÷ 7.671 days) = $228,559

    Roya chooses to use the discount method and, because she has no other capital gains or capital losses, she includes a net capital gain of $114,280 ($228,559 × 50%) on her 2018 tax return.

    End of example

    See also:

    If you inherited the home

    If a person acquired their main residence on or after 20 September 1985 and they died and it passed to you as a beneficiary or as trustee of their estate after 20 August 1996, you are taken to have acquired the dwelling at its market value at the time you first used it to produce income if:

    • you first used the dwelling to produce income after 20 August 1996
    • when a CGT event happens to the dwelling, you would only get a partial exemption because you used the dwelling to produce assessable income during the period you owned it
    • you would have been entitled to a full exemption if the CGT event happened to the dwelling immediately before you first used it to produce income
    • the CGT event did not happen to the dwelling within two years of the person's date of death.

    If all of the above apply, you must work out your capital gain or loss using the market value of the dwelling at the time you first used it to produce income. You don't have a choice.

    See also:

    If you use your home to produce income and then stop living in it

    If you use any part of your home to produce income before you stop living in it, you can't apply the 'continuing main residence status after moving out' rule to that part. This means you can't get the main residence exemption for that part of the dwelling either before or after you stop living in it.

    Example: Ceasing to live in a home after part of it is used to produce income

    Helen purchased a house under a contract that settled on 1 July 1998 and she moved in immediately. She used 75% of the house as her main residence and the remaining 25% as a doctor's surgery, which she used until 30 June 2012.

    On 1 July 2012, she moved out and rented out the house until it was sold under a contract that settled on 30 June 2018. She made a capital gain of $400,000 when the house was sold.

    Helen chooses to treat the house as her main residence for the six years it was rented out.

    As 25% of the house was not used as her main residence during the period before Helen stopped living in it, part of the capital gain is assessable:

    $400,000 × 25% = $100,000

    Because Helen entered into the contract to acquire the house before 21 September 1999 and sold it after that time, and owned it for at least 12 months, she can use either the indexation or discount method to calculate her capital gain.

    The 'home first used to produce income' rule is irrelevant because she used it to produce income from the time she purchased it.

    End of example

    Small business CGT concessions

    If you're not entitled to a full main residence exemption because you use your home for business purposes, you may be able to apply the small business CGT concessions to reduce your capital gain. The concessions are not available if the main use of the premises is to derive rent.

    See also:

    Last modified: 29 Jun 2018QC 52191