Tax Tip 248: CGT when Renting out a Room in your Main Residence

Tax Tip 248: CGT when Renting out a Room in your Main Residence

Renting out a room of your main residence will mean you lose part of the CGT exemption status of your house.


The cost base of the property will be reset to the value at the date of first renting the rooms out and the portion of the gain subject to CGT will be worked out on the basis of the number of days the property was rented, and the floor area.


This is best explained by an example

Bart bought his house in 2010 for $500,000 with $30,000 worth of costs.

He lives there on his own, but after a while his mate, Millhouse, moves in. It is a 2 bedroom house and Millhouse has access to the kitchen, toilet, the living room and the dungeon. Bart works it out to be roughly 40% of the floor space.

Millhouse moves in for 1 year for the whole of 2015.

Bart remains living their until it is sold in 2017.


Calculations

Step 1: The market value of the property when first rented

$600,000 is the figure for the value on the day Millhouse moved in.


Step 2: Sale price less costs.

$700,000 sale price with $20,000 in commission to the agent = $680,000


Step 3: Work out the Gain

$680,0000 less the cost base of $600,000 = $80,000


Step 4: Apportion the gain based on period rented

Total time owned was 7 years.

Total time rented was 1 year.

As a percentage 1/7 = 14.28%

$80,000 x 14.28% = $11,428


Step 5: Reduce this based on portion of property used

$11,428 x 40% = $4,571


Step 6: Apply the 50% CGT discount

$4,571 x 50% = $2,285


Step 7: Add to other income

Bart’s income for the year will be increased by the figure at step 6.

If Bart was on the top marginal tax rate the capital gains tax on the sale of his main residence would be something like $1,074



I should add that while renting the property the proportion of the costs relating to the room could also be claimed - such as interest, rates, power etc.
Taking these into account Bart has probably come out paying less tax by renting the room than he had to pay, he also benefitted from the extra income so he should be ahead.

 

Bart may not have to reset the costbase if the house was used to produce income (sole trader / partnership) whether or not any deductions were ever claimed prior to the rental. I'm often finding taxpayers who started a minor business that later stopped that may benefit from this. Barts Lemonade & Tomaco stand may be helpful

Its worth exploring since s118-192 which resets the costbase isnt an option. Its important to determine if the taxpayer MUST use it or is unable to do so.

 

Unless the boarder pays in physical cash right?

 

how they pay is irrelevant.

 

Not when you get audited. People who pay cash can easily report tax fraud to the ATO. They check and find no reported income. They then wont believe a word you say.

 

If the property is a short term rental that forms part of a hospitality business it might enjoy the sale tax free using the small business cgt concessions.

This would need more than just a room. If you offered breakfast, managed say 5 rooms, tours, ran a website promoting the accomodation. Arranged the licenses, did the Airbnb or stayz things, and did other things reminiscent of a business you might still get it tax free.

 

Is there any difference if Millhouse is classified as a boarder (ie includes food in his rate)?

 

It is a domestic arrangement ? Domestic arrangements eg family, friends etc may be non-taxable. A repetition or a different arrangement is just a effort to call income something else.

Its like a Uber driver picking up a hitch hiker and asking for $20 and saying its private, not income. Just because its a sale outside the app doesnt mean its not income

Tax Ruling IT 2167 covers this. Having a "rate" is more a concern. If Millhouse was staying and chipped in $20 for food then its likely not income and the costs are non-deductible too. No CGT impact. But a frequency (even infrequent) or other arrangement (eg Airbnb) or an expectancy for a charge probably wont comply if he is not close family / friend. Ever.

 

a boarder would not have a 'rate', just be paying for food and perhaps internet, electricity usage.

 

How would LMI be calculated? If LMI was required on the purchase initially and say 2 years later decide to rent out 40% of the property.

 

LMI only potentially deductible over 5 years so you would have to apportion it for the 3 remaining years.

 

So LMI is only deductible within the first 5 years? So if you rent out on the 6th year, LMI is no longer deductible?

 

yes

Edit - some could be deductibe in year 6 as it must be apportioned in the first year

 

LMI is a borrowing expense. Borrowing expenses over $100 must be claimed over a term of 60 months (actually 1826 days) from the date the loan commenced. This is calendar 5 years but is NOT 20% each year. After 60 months no further deduction is available. This may however occur within the 6th tax period eg

Loan advanced May 2014 LMI is $4560

Deductions :
2014 (2/60) $152
2015 - 2018 (12/60) $912 pa
2019 $ (10/60) $760

 

What if the following applies:

House 1 purchased in 2015 and used as PPOR.

Land purchased in 2017 and house built and moved into whilst doing minor repairs on house 1 with intent to sell later down the track.

Circumstance changes and house 2 isn't looking like the ideal "forever" home so put on market and sold in 2019.

Taxpayer wants to claim MRE on house 2 as it has the bigger gain.

House 1 loses its PPOR status from the time of land purchase of house 2.

Whilst taxpayer was living in house 2 they rented a room in house 1 for cash to a close friend to help maintain a bit of the mortgage and it was put on the market and sold as taxpayer found a new "forever" home opportunity and family circumstances changed etc.

Does the CGT on house 1 need to be apportioned from time of losing its PPOR status (2017) and then again when the renter moved in (2018)?

 

Yes

 

Thanks Terry.

So the CGT calc for the period the house was rented gets a cost base reset at that date?

Effectively there will be two cost bases used for this exercise?

 

Apportionment needed

 

An asset cannot have two costbases.

House one will have an apportionment since the property has period of time when it is exempt (ie 2015-2017) and different periods of time when taxed. Eah needs to be calculated to correct no of days. And the CGT costs included in calculating oveall profit. However since #2 was constructed the time from when the land was acquired will be a relevant date NOT the date you move into #2. Its a ironic issue with a newly constructed main residence that the property can and will be a main residence despite it not being complete. Normally this isnt allowed but for this issue.

You will also be allowed to add to house #1 costbase any non-deductible costs of ownership throughout the ownership period. These are called third element costs. This will reduce the profit subject to the taxable / exempt days eg loan interest rates, insurance, maintenance etc. Cost you claim on #1 when it was rented out would be excluded.

This is a good example of the issue some taxpayers face of not keeping CGT records for their own home assuming it will be tax free.

 

This is very interesting. I'm wondering what the differences are between this and how you would report income and claim deductions for a pure investment property.
I assume that Bart reported the income he received from Millhouse during 2015 on his taxes like a good boy...
Q1. Does that mean he can also claim deductions for power and gas bills, strata and council and water rates, and other things investors claim from investment properties, just at an apportioned rate of usage (so maybe 50%)?
Q2. Could he also claim an apportioned year of depreciation for that kitchen and bathroom he renovated the second week that Millhouse lived there?
Q3. I guess I'm asking if there are exceptions to what you could claim (apportioned) for renting out a room in your home compared to a pure IP.