Renting part of permanent residence
Q: I’ve just purchased my first property, a three-bedroom home. I’m planning to move in and rent out the other two bedrooms. Can I claim my interest payment as a tax deduction along with other expenses for the property?
A: You can use your home for dual purposes simultaneously – that is, part of your home can be used as your principal place of residence and part of your home can be used for income-producing purposes as per your plans to rent out the other two rooms in the home. In addition to the other two bedrooms, you will also co-rent the other communal areas, such as the kitchen, bathroom, foyer, backyard, driveways, etc, as your tenants will most likely need to access and use these areas as well.
Provided that you charge an appropriate market value rental for the two bedrooms and on an arm’s length basis, you can claim the property’s outgoings, depreciation and interest expense on the loan as income tax deductions but only on an apportionment basis. Apportionment generally applies to the areas in the home that you will be using for income-producing purposes relative to the total area of the home.
In simple terms, if your home is 600sqm and you are using 300sqm for income-producing purposes, then you will only be entitled to claim 50% of the property’s outgoings, depreciation and interest expense on the loan as allowable income tax deductions.
The other factor you need to consider is the potential capital gains tax implications if you ever sell your home in the future. Assuming the property is held in your own individual name, you will not be eligible for the full capital gains tax exemption if you sell the property because you will have used part of the home for income-producing purposes. In this instance, if you ever sell your PPOR for a profit in the future, you will most likely pay some capital gains tax on part of the profit on your capital gain.
– Angelo Panagopoulos
CGT on owner-occupier residence turned investment
Q: I’m a local resident and bought my main residence in September 1990. I lived in it for three years, then I was posted overseas with my family and have been drawing foreign income and paying the other country's tax.
The house was rented out from the end of 1993 for 14 years until I came back at the end of 2007 and lived in it again. I then moved out and rented it out again in September 2011 for two years until September 2013 when I sold it.
I held the property for 23 years, and stayed and rented out in the following sequence. Can you please advise how the capital gains tax is calculated in this case?
Lived in PPOR for 3.25 yrs then went to work overseas
Rented property out for 14 yrs
Returned from overseas and lived in it for 3.75 yrs
Moved out and rented it again for 2 yrs
Then sold the property
A: Assuming your property was held in your individual name(s), your capital gains tax calculations and liability depend on whether you nominated any other PPOR (including overseas) during the two periods of time you were overseas and using your Australian main residence for income-producing purposes. So I will therefore advise on both scenarios.
Not nominating another PPOR while overseas
If you didn’t nominate any other PPOR while you lived overseas, then you will be eligible for the capital gains tax six-year exemption for both periods of time that you lived overseas and used your property for income-producing purposes.
Therefore, the capital gains tax would be calculated as follows:
● 1990–1999
Not subject to CGT (three years' main residence plus six-year rule)
● 1999–2007
Subject to CGT because, since 1999, CGT has been assessed on any continuous period after a property is rented out for six continuous years. You will be required to obtain a valuation in 1999 and 2007
● 2007–2011
Not subject to CGT (as this was your main residence for this period)
● 2011–2013
Not subject to CGT (within six-year year rule)
Therefore, your capital gain (or loss) will be the difference between what the property was worth in 2007 and what the property was worth in 1999, based on the valuations.
Nominating another PPOR while overseas
If you did nominate another PPOR each time you moved out to go overseas, then you will be assessed for capital gains tax for the whole period of time that you were using your Australian property for income-producing purposes.
The capital gains tax would be calculated as follows:
● 1990–1993 Not subject to CGT (three years' main residence)
● 1993–2007 Subject to CGT. You will be required to obtain a valuation in 1993.
● 2007–2011 Not subject to CGT (as property was your main residence during this period)
● 2011–2013 Subject to CGT
● 1993–2013 You will be required to determine the total number of days when the property was used for income-producing purposes during this period. This is divided by the total number of days of the ownership period (1993-2013), and the CGT on this proportion will be assessed on a pro rata basis.
I note that you sold the property in September 2013, so please be aware that if you were a non-resident of Australia for income tax purposes after 8 May 2012, you will not be eligible for the CGT 50% discount.
– Angelo Panagopoulos
Reducing tax on PPOR turned IP and back to PPOR
Q: We have two different scenarios we are considering that we wanted to know the tax implications for:
1. Our investment property is currently vacant and we’re considering moving back into it for a couple of months to do some repairs and improvements before renting it out again. Can we claim these repairs/improvements as a tax deduction? I'm assuming that while we live there we will be unable to claim rates, loan interest, etc?
2. If we decided to sell instead of renting, what would our capital gains tax obligation be? We originally purchased the property as our PPOR and have rented it out for three years (after living in it for three years). We currently have another PPOR. Would it reduce our tax bill if we moved back in for a while and made the investment property our PPOR again? If so, what is the minimum amount of time we would need to live there for?
A: In relation to the first part of your question: as it seems your intention is to rent out the property again as soon as is practicable after the repairs/improvements are completed, you can claim the interest expense on the loan as an allowable income tax deduction. If the intention is different, then you can capitalise the interest expense on the loan as well. Where the repairs/improvements are concerned, if the intention is to rent out the property as soon as is practicable after the repairs/improvements are completed, you can also claim the repairs as income tax deductions. The improvements, however, must be depreciated for the useful life of the improvements. I would also recommend obtaining a scrapping schedule prior to commencing the improvements, and upon completion, obtaining a depreciation schedule. Both schedules can be prepared by a quantity surveyor.
With respect to the second part of your question: you can only nominate one property as your PPOR at any given time, so it therefore comes down to whichever property provides you with the best CGT outcome. For example, if you intend to sell the property in question and move into the property prior to sale for a few months, it may reduce your CGT liability (on a pro rata basis). However, your other property that you are currently living in will then be subject to future potential assessable CGT because you cannot have two properties as main residences simultaneously – you can only nominate one property.
Therefore, it comes down to which property will give you the best tax outcome, and you do have the option to choose. Take note, however, that if your current PPOR (not the investment property you are referring to in this question) is in your individual name(s) and you resided there from the time of purchase (and nominated this property as your PPOR), your best tax outcome will be to continue to live in your current property (because, all things being equal, you will preserve the CGT-free main residence exemption). Then, if you decide to sell the investment property you will be partially CGT-exempt because you have already lived in the property for the first three years.
There is no minimum period in the tax legislation for residing in a dwelling as it always comes down to a case-by-case basis and a question of fact. Take note, however, that if the dominant purpose of doing something is for a tax benefit, then under Part IVA of the Tax Act there are heavy penalties that could be imposed if this were established.
– Angelo Panagopoulos
