Tax Q&A: CGT Discounts and the Six-Year Rule

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Q: We built a house, our first home, in 2009 and lived in it till July 2015. Then we bought another house elsewhere (a higher-value property than the first home) and moved into it in July 2015. Our first home is currently a rented property, which has been let out from July 2015 until now. We plan to sell the rented property.

• Are we liable for a partial CGT discount when the rented property is sold?

• Can we apply the six-year rule for the rented property and not pay any CGT? 

• If we can apply the six-year rule for the first home being sold, is it tax efficient, given the second property has a higher expectation of capital gain on a potential sale?

Thanks, Sanjee

A: In answer to the first part of your question, yes. If you do not choose to treat the rented property as your main residence under the ‘six-year rule’ until its sale has been completed, then, assuming you owned the property in your individual names, you will be liable for CGT on a portion of the gain on the sale of the rented property. 

There is an allowance for both properties to be treated as your main residences for the last six months that you owned the rented property, meaning you could further reduce the capital gain on the sale of that property. However, you will not be able to benefit from this rule because the rented property was not your main residence for a period of at least three months in the 12-month period prior to the sale of the rented property. In addition, the rented property has been used to produce income (rent) during that 12-month period.

"There is an allowance for both properties to be treated as your main residences"

Applying the partial exemption, your taxable capital gain from the sale of the rented property will be limited to the portion of the overall capital gain you make from that sale represented by the ratio of:

•     the number of days the rented property was not your main residence; to

•     the total days you owned the rented property.

The taxable capital gain so calculated should be reduced further by the 50% CGT discount, as you have owned the rented property for more than 12 months.

Although you have used the rented property to produce income, but not for more than six years, you can choose to treat it as your main residence until the time the sale completes. If you make that choice, you will be entitled to the benefit of a full main residence exemption on the sale of the rented property.

However, by making that choice, you will not be able to treat the second property you are now living in as your main residence for the whole period of ownership of that property. 

Accordingly, when that property is sold, you will only be entitled to a partial main residence exemption calculated by reference to the ratio of:

•     the days the second property can be treated as your main residence; to

•     the total number of days you owned the second property.

Whether it would be tax efficient to treat the rented property as your main residence until the time the sale completes will depend on the size of the gain that will be made on the rented property and the length of time you plan to reside in 

(and/or keep) the second property. In that respect, the ratio of the number days the second property was not your main residence to the number of days you have owned it will decrease the longer you own the second property. Accordingly, the taxable proportion of the gain should decrease the longer you reside in and hold the second property.

Mathew Brittingham

is a tax and revenue partner at Finlaysons Lawyers

Disclaimer: The advice contained in this article is for general information only and should not be taken as financial advice. Please make sure to speak to a qualified professional person before making any investment decision.