• Dwelling used to produce income

    Attention

    Warning:

    This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

    End of attention

    Usually, you cannot get the full main residence exemption if you:

    • acquired your dwelling on or after 20 September 1985 and used it as your main residence
    • used any part of it to produce income during all or part of the period you owned it, and
    • would be allowed a deduction for interest had you incurred it on money borrowed to acquire the dwelling (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, and
    • 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.

    Example 65: Renting out part of a home

    Thomas purchased a home under a contract that was settled on 1 July 1999 and sold it under a contract that was settled on 30 June 2010. The home was his main residence for the entire eleven years.

    Throughout the period Thomas owned the home, a tenant rented one bedroom, which represented 20% of the home. Both Thomas and the tenant used the living room, bathroom, laundry and kitchen, which represented 30% of the home. Only Thomas used the remainder of the home. Therefore, Thomas would be entitled to a 35% deduction for interest if he had incurred it on money borrowed to acquire his home. The 'home first used to produce income' rule does not apply because Thomas used the home to produce income from the date he purchased it.

    Thomas made a capital gain of $120,000 when he sold the home. Of this total gain, the following proportion is not exempt:

      

    capital gain

    x

    percentage of floor area

    =

    taxable portion

    $120,000

    x

    35%

    =

    $42,000

      

    As Thomas entered into the contract to acquire the home before 11.45am (by legal time in the ACT) on 21 September 1999, and entered into the contract to sell it after he had held it for at least 12 months, he can use either the indexation or the discount method to calculate his capital gain.

    If you set aside and use part of the dwelling exclusively as a place of business, you cannot get a CGT exemption for that part of the dwelling by not claiming a deduction for the interest. Nor can you include interest in the cost base if you are entitled to a deduction but do not 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.

    When a CGT event happens to the home, the proportion of the capital gain or capital loss that is taxable is an amount that is reasonable according 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 if the dwelling is available (for example, advertised) for rent.

    Example 66: Running a business in part of a home for part of the period of ownership

    Ruth bought her home under a contract that was settled on 1 January 1999. She sold it under a contract that was entered into on 1 November 2009 and was settled on 31 December 2009. It was her main residence for the entire eleven years.

    From the time she bought it until 30 June 2004, Ruth used part of the home 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 home.

    When she sold the home, Ruth made a capital gain of $80,000. The following proportion of the gain is taxable:

      

    capital gain

    x

    percentage of floor area not used as main residence

    x

    percentage of period of ownership that that part of the home was not used as main residence

    =

    taxable portion

    $80,000

    x

    25%

    x

    50%

    =

    $10,000

      

    As Ruth entered into the contract to acquire the home before 11.45am (by legal time in the ACT) on 21 September 1999, and entered into the contract to sell it after she had 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 does not apply, because Ruth used the home to produce income from the date she purchased it.

    Further information

    For more information on rental properties (for example, negative gearing and deductions), see Rental properties.

    End of further information

     

    Home first used to produce income

    If you start using part or all of your main residence to produce income for the first time after 20 August 1996, a special rule affects the way you calculate your capital gain or capital loss.

    In this case, you are taken to have acquired the dwelling at its market value at the time you first used it to produce income if all of the following apply:

    • you acquired the dwelling on or after 20 September 1985
    • you first used the dwelling to produce income after 20 August 1996
    • when a CGT event happens to the dwelling, you would get only a partial exemption, because you used the dwelling to produce assessable income during the period you owned it, and
    • 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.

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

    A similar rule applies if you inherit a dwelling that was the deceased's main residence and you use it to produce income, see Using a home you inherited to produce income.

    Attention

    Full exemption 

    You may have made the choice to treat a dwelling as your main residence after the dwelling ceases to be your main residence (see Continuing main residence status after dwelling ceases to be your main residence). In this case, if the dwelling is fully exempt, the 'home first used to produce income' rule does not apply.

    End of attention 

    In working out the amount of capital gain or capital loss, the period before the dwelling is first used by you to produce income is not taken into account. The extent of the exemption depends on the period after that time and the proportion of the home used to produce income. The example on this page explains this.

    If the 'home first used to produce income' rule applies and the period between when you first used the dwelling to produce income and the CGT event happening is less than 12 months, the CGT discount method is not available.

    Example 67: Home becomes a rental property after 20 August 1996

    Erin purchased a home on 0.9 hectares of land in July 2000 for $280,000. The home was her main residence until she moved into a new home on 1 August 2003. On 2 August 2003, she commenced to rent out the old home. At that time, the market value of the old home was $450,000.

    Erin does not want to treat the old home as her main residence (see Continuing main residence status after dwelling ceases to be your main residence) as she wants the new home to be treated as her main residence from when she moved into it.

    On 14 April 2010, Erin sold the old home for $496,000. Erin is taken to have acquired the old home for $450,000 on 2 August 2003, and calculates her capital gain to be $46,000.

    Because Erin is taken to have acquired the old home on 2 August 2003 and has 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 $23,000 on her 2010 tax return.

    Example 68: Part of home first used to produce income after 20 August 1996

    Louise purchased a home in December 1991 for $200,000. The home was her main residence. On 1 November 2007, she started to use 50% of the home for a consultancy business. At that time the market value of the house was $320,000.

    She decided to sell the property in August 2009 for $350,000. As Louise was still living in the home, she could not get a full exemption under the 'continuing main residence status after dwelling ceases to be your main residence' rule. The capital gain is 50% of the proceeds less the cost base.

      

    percentage of use

    x

    (proceeds - cost base)

    =

    capital gain

    50%

    x

    ($350,000 - $320,000)

    =

    $15,000

      

    Louise is taken to have acquired the property on 1 November 2007 at a cost of $320,000. Because she is taken to have acquired it at this time, Louise is taken to have owned it for less than 12 months and must use the 'other' method to calculate her capital gain.

    If you make the choice to continue to treat a dwelling as your main residence after it ceases to be your main residence (see Continuing main residence status after dwelling ceases to be your main residence), and you do not get a full exemption, the 'home first used to produce income' rule may apply.

    Example 69: Dwelling used to produce income for more than six years and first used to produce income after 20 August 1996

    Roya purchased an apartment in Australia for $280,000 under a contract that was settled on 15 September 1994, and immediately started using the apartment as her main residence.

    On 29 September 1996, she moved overseas and began renting out the apartment. During the time she was overseas, she did not acquire another dwelling and continued to rent out the apartment. After she returned to Australia in July 2009, she sold the apartment for $555,000. Settlement occurred on 29 September 2009 and she incurred $15,000 in real estate agent's and solicitor's costs.

    As Roya rented out the apartment, she is only entitled to choose to continue to treat the dwelling 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.

    As Roya is only entitled to a partial CGT exemption, she first used the property to produce income after 20 August 1996, and she would have been entitled to a full CGT exemption for the dwelling immediately before she started renting it out, she treats the dwelling as having been acquired on 29 September 1996 at the market value at that time, which was $340,000.

    Roya works out her capital gain as follows:

    capital proceeds

    $555,000

    cost base: ($340,000 + $15,000)

    $355,000

    total capital gain

    $200,000

     

    $200,000

    x

    2,558 days
    4,749 days

    =

    $107,727

    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 $53,863 ($107,727   50%) on her 2010 tax return.

    Last modified: 10 Sep 2010QC 28058