Tax Tip 218: Renting out Part of the Main Residence and CGT

When renting out part of the main residence this will make the property subject to CGT. The 6 year rule cannot be used unless you are absent from the property and by renting out a room and living in another room you would not be absent.


It is possible to claim expenses associated with the property in proportion to the area of the property rented out – renting out half of a 2 bedroom unit would mean half of the costs could be claimed – interest, rates, strata etc.

But when a property becomes income producing its cost base is reset to the market value at the date it first produces income.

These days valuations are dropping so someone renting out part of their main residence could be making a problem for themselves because they are lowering their cost base, which means higher CGT potentially, and also the costs incurred up to the point of renting the property out would not be useable to reduce CGT.


Example

Maggie owns a 2 bedroom unit purchased last year for $500,000. Settlement costs were about $20,000.

A year later the unit is valued at $400,000 and Maggie decides to rent out one of the bedrooms. She can now claim half of the costs associated with the property and makes a loss of about $5,000 per year which saves her $2,000 in tax.

Several years later Maggie sells the property for $500,000 and thinks great, there is no capital gain so no CGT payable.

Maggie is wrong!

When the property is first rented out the cost base is reset to the market value at that point. It was $400,000 then so the capital gain when sold was actually $100,000.

Maggie can’t even use the $20,000 settlement costs to reduce this because it no longer counts when the cost base is reset. The $10k selling costs though could be taken into account. This makes the gain $90,000 and as only half of the property was income producing this is reduced to $45,000 then the 50% CGT discount is applied to make it $22,500

So even though there was no increase in the property since purchase, and Maggie actually lost about $30k on the sale she still has to pay about $10k in tax when the property is sold.

(but she still might be ahead when the rental income and tax saved is taken into account)

 

What about if the main residence was bought before September 1985, meaning it's a pre-CGT property. Wouldn't it still be 100% CGT exempt when sold?

What about if the main residence is a pre-CGT property then in the 90's another building is built onto the same block of land (on one title) and rented out. What happens when this one titled property with two buildings gets sold?

What happens if at that time Maggie doesn't get a registered valuer out to value the property at $400k, how will the ATO be able to determine Maggie's unit is worth exactly $400k when she started renting the unit?

 

Pre CGT property always exempt, unless you build on it, the partially subject to CGT.

It is up to Maggie to nominate the value of her property to work out CGT - self assessment, but she has to justify it if audited.