In an environment of booming house prices, many people are tempted to capitalise on the value of what is almost certainly their most valuable asset in any number of creative ways.
As a general rule, your family home isn’t subject to capital gains tax (CGT) when you sell it.
However, here at H&R Block we encounter clients every day who are using their property as far more than just their family residence. Unfortunately, in many cases, there can be tax consequences, both in terms of immediate income tax liabilities and – down the track - capital gains tax arising on the ultimate disposal of the property.
We’ve collected together some of the transactions we’ve seen and analysed the tax impacts.
If you are renting out a room, the rental income will usually be taxable. You should be able to claim a tax deduction for costs such as insurance and depreciation of furniture and fittings in the rooms available for rental as well as making a claim for part of your utilities, rates and water bills.
The family home is generally exempt from CGT but if you rent out a room, part of any profit on the sale of the property may be liable to CGT, payable on a pro-rata basis for the percentage of floor space rented out.
A good tip is to get the property valued before you start to rent out the room since CGT will only be due for the period the room is used to produce income.
By comparison, letting a room for student accommodation can be non-taxable, provided you are only covering your costs rather than making a profit. These arrangements are usually made through an educational institution for foreign students with the amount paid set by the institution to cover food, laundry and other costs.
The ATO describes these arrangements as ''non-economic rentals'' but hosts are advised to get some sort of agreement in writing (a private ruling for instance) from the ATO to give certainty to their position, since issues can arise where the ATO regards the level of board as excessive.
With the growth of websites like Airbnb, increasing numbers of people are turning part of their home over to B&B. If you’re letting a room out for B&B, your tax treatment will depend on factors including what you charge, what services you provide, where you advertise and the regularity of income. If the B&B is designed to make a profit, then income tax will be payable. Again, CGT on the sale of the property will be an issue because the residence exemption won’t apply to the part which is rented but if you are running a commercial venture you may be able to claim small-business CGT concessions.
Commerciality is assessed on such things as regularity of bookings, the number of rooms available and length of time they are let, but this is a complex area and getting professional advice is a good idea. Read our tax guide for AirBnb hosts.
As soon as the property ceases to be your main residence and becomes an investment, an immediate tax benefit will arise; the interest on any outstanding loan on the property will become tax deductible. Any other costs of ownership, like land and water rates, insurance and maintenance costs will also be deductible. The rent you receive will of course be taxable
Unfortunately, because the property is no longer your main residence, the CGT exemption will be affected. When you dispose of the property, any profit will have to be apportioned between the period of main residence and the period the home was used as an investment property and the CGT exemption will only apply to the former period.
Note that there are provisions commonly referred to as the six-year rule which allow an owner to be temporarily absent from their home without losing the full benefit of the CGT main residence exemption. This rule provides that the property’s owner can be temporarily absent from the home for a period of up to six years at a time without losing the exemption, provided that no other property is treated as the main residence for tax purposes during that period. The owner can rent the property out during that time and reset the six-year period each time they move back.
If you live on a large block, it can be very tempting to subdivide the block, sell off the surplus land and continue to reside on the part of the block that contains the residence.
The main tax concern here is with CGT. The subdivision itself doesn’t trigger a capital gain because there is no disposal but when you subdivide, you’ll need to apportion the original cost of the land between the subdivisions. You’ll need to engage a valuer to undertake that exercise
When there’s a subsequent sale of one or more of the subdivided plots, CGT may be an issue. If you sell the part on which your home sits, you won’t generally be liable for CGT because of the main residence exemption.
If the part sold is adjacent to or surrounding your home, the main residence exemption usually won’t apply and CGT will be payable.
If you choose to build a house on the adjacent plot and then sell the land with the house, you might be regarded as undertaking a profit-making venture, meaning that you could be liable to income tax (not CGT) on the sale and might also have GST obligations.
If the flat is rented out – whether to granny or otherwise – the rental income received will be taxable.
Normally, your main residence will be exempt from capital gains tax (CGT) when you dispose of it but putting a granny flat on your property may mean that part of the profit on sale will become liable for CGT. This will mean that a capital gains tax calculation will have to be done for the whole property with an apportionment done between the main residence and the granny flat with tax potentially payable on the granny flat element.
The CGT would be based on how much space the granny flat takes up. You would also need to consider how long the granny flat has been in existence. If you owned the property for 10 years but the granny flat was only built 5 years ago, you don’t need to worry about CGT on the first 5 year period.
If granny really does live in the flat and you can demonstrate that the granny flat space is an integrated part of the household lifestyle, you may be able to argue that the main residence exemption should cover the granny flat too.
This is increasingly common, particularly where a small number of people live in a large property. If you don’t need all that space, why not convert part of the house into a self-contained residence in its own right?
If you retain one mortgage over the whole property, the interest element relating to the part of the home which is now rented out will become tax deductible and can be offset against the taxable income earned on rent.
The major tax impact is again on the CGT main residence exemption. This will cease to apply to the part of the property which is rented out which means that on a sale of the property, there will have to be an apportionment by floor area and by time, with full exemption available up to the date of zoning and partial exemption thereafter.
If you’re looking to make your property work for you by any of these means, don’t rush into it without considering the tax consequences. Even if the action you take now doesn’t have an immediate tax impact, you might find that when you finally decide to sell-up, the main residence exemption which you thought you’d qualify for is no longer available or is only partially available.
Book an appointment with H&R Block and we’ll discuss your plans and the potential tax consequences so you can proceed confident that you’ve got the tax situation covered.
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