The six year rule is an important consideration for homeowners who rent out part of their property, particularly in relation to capital gains tax (CGT).
Understanding how this rule works can help you make informed decisions about renting out a room in your home while maximising your tax benefits.
What is the six year rule?
The six year rule allows homeowners to maintain their main residence exemption from CGT for up to six years while renting out their property. This means that if you rent out your home or a portion of it, you can still potentially avoid CGT on any capital gains when you sell the property, provided you meet certain conditions.
Key conditions of the six year rule
- Main residence status
To qualify for the six year rule, the property must have been your main residence before it was rented out. If you move out and rent it, you can still claim the main residence exemption for up to six years. - Ceasing to be your main residence
The property must cease to be your main residence for the exemption to apply. If you continue living in the property while renting out a room (for example, through platforms like Airbnb), you may lose part of your main residence exemption based on the area rented and the duration of the rental. - Partial exemptions
If you rent out only a portion of your home (such as a room), the CGT exemption may be reduced based on the floor area rented and the length of time it was rented out. For instance, if you rent out 20% of your home for four years, that portion may not be eligible for the full exemption when you sell.
Capital gains tax implications
When selling a property that has been partially rented out, it’s crucial to understand how CGT will apply.
- Calculating CGT
If you’ve rented out part of your home and decide to sell, you’ll need to calculate any capital gain based on how long it was rented and what portion was used for rental purposes. The gain is generally calculated by determining the increase in value from when you purchased the property to when it was sold. - Discounts and deductions
If you’ve owned the property for more than 12 months, you may be eligible for a 50% discount on any capital gain. Additionally, certain costs associated with buying and selling the home can be included in the cost base, potentially reducing your taxable gain.
Example scenario
Consider a homeowner who rents out a room in their house (15% of total floor space) for three years while living there.
The homeowner must declare all rental income received each year as part of their taxable income. This income is subject to taxation at their marginal tax rate.
After owning the home for 15 years, they decide to sell it and make a net capital gain of $300,000.
Under the six year rule and after applying applicable discounts, they may only need to include a small portion of that gain – around $4,500 – in their assessable income due to the period it was rented.
The six year rule provides valuable flexibility for homeowners who wish to rent out their properties while retaining some tax benefits.
However, navigating CGT implications can be complex, especially if you’re not entirely clear on how much of your property is being rented and for how long.
It’s advisable to keep thorough records and consult with our tax professionals to ensure compliance with Australian tax laws and maximise any potential benefits from renting out part of your home.
Here’s the breakdown of our calculations for this example.
- Total capital gain
The homeowner makes a net capital gain of $300,000 upon selling the property. - Ownership duration
The property was owned for 15 years, and the room was rented out for 3 years. - Portion rented out
The room represents 15% of the total floor space of the home. - CGT discount
Since the property was held for more than 12 months, the owner is eligible for a 50% CGT discount.
Calculation steps
To determine how much of the capital gain is taxable, we can follow these steps:
- Calculate the portion of the gain attributable to the rental period
Since the room was rented out for 3 years out of 15 years, this accounts for 3/15 = 20% of the ownership period. - Calculate the portion of the gain attributable to the rented area
The room represents 15% of the total property, so this portion must also be considered. - Combine these factors to find the taxable gain
First, calculate 20% of the total gain:
$300,000 × 20% = $60,000
Then, calculate 15% of that amount:
$60,000 × 15% = $9,000
Finally, apply the CGT discount (50%):
$9,000 × 50% = $4,500
The homeowner would only need to include $4,500 in their assessable income due to renting out a room for three years while living in their home for a total ownership period of fifteen years. This amount reflects both the rental duration and the proportion of space rented out along with applying the CGT discount appropriately.