Tax Implications When Buying a Holiday Home
Every year, the ATO looks closely at tax claims which relate to holiday homes to ensure that people aren’t over-claiming tax deductions. The boom in holiday home ownership throws up particular challenges for the taxman, both in making sure that they know exactly who owns what and also in making sure that taxpayers aren’t rorting the system.
As part of that process, the ATO stated last year that it will write to property investors who own properties in popular holiday areas to remind them to claim only the deductions to which they are entitled.
So what do you need to know to get it right?
Declare rental returns as income
If you rent out your holiday home during the period you’re not using it, you need to declare the rental returns as income.
Renting out the holiday home
You can only claim deductions for the periods the property is rented out or is genuinely available for rent. Periods of personal use can’t be claimed. This is particularly important for holiday homes, where the ATO regularly finds evidence of home-owners claiming deductions for their holiday pad on the grounds that it is being rented out, when in reality the only people using it are the owners, their family and friends, often rent-free.
Claiming the costs of repairs and renovations
The costs to repair damage and defects existing at the time of purchase or the costs of renovation cannot be claimed immediately. These costs are deductible instead over a number of years. Expect to see the ATO checking such claims and pushing back against claims which do not stack up.
Splitting income and deductions between owners
The ATO is concerned that husbands and wives are in some cases splitting income and deductions so that the bulk of the tax benefit goes to the higher earning spouse, even though the property is actually owned 50:50. Make sure that if you jointly acquire a property with your spouse, everything – income and deductions – needs to be split equally.
What you can’t claim as a deduction
There are also a number of costs which you can’t deduct, including costs associated with:
- acquiring and disposing of the property, including conveyancing costs, advertising costs and stamp duty. These costs would normally be of a capital nature and would be added to the cost base of the property
- expenses you don’t actually incur as the owner of the property, for example costs in relation to the property which the person renting the property pays
- expenses not related to the rental of the property, for example interest on a loan which might originally have related to the property but where additional funds have been drawn down to fund private activities
- there are other expenses which, whilst not immediately deductible, can be claimed over a number of years. These include borrowing expenses (ie, those costs linked to the financing of the property such as title search fees, loan establishment fees, stamp duty on the mortgage, etc), depreciation costs on assets used in the building (such as air conditioners, hot water systems, etc) and capital works deductions (such as costs spent on altering, improving or extending the structure of the building). But remember, you can only claim the proportion of costs which relate to periods the property was available for rent.
Importantly, the ATO now has access to numerous sources of third party data, including access to popular rental listing sites for both long term and holiday rentals, so it is relatively easy for them to establish whether a claim that a property was ‘available for rent’ is correct.
Will I Pay Tax If I Sell My Family Home?
Typically, when you sell an asset you must pay capital gains tax (CGT) on any profit made on the sale. For most of us, the most valuable asset we own is our family home and with house prices heading upwards across large parts of the country, many of us stand to make a large profit if we sell.
Does that mean that you have to pay CGT when you sell your house?
Fortunately, in most cases, the answer is no. The tax law provides an automatic exemption for any capital gain (or loss) that arises from the sale of a taxpayer’s main residence. However, this isn’t a blanket exemption. There remain situations where some or all of the gain arising on disposal of your main residence may be liable for CGT.
WHAT IS MY MAIN RESIDENCE?
In short, it’s your home. The ATO has set out some of the factors that determine whether the property you have disposed of is your main residence. These include whether:
- You and your family live there
- You have moved your personal belongings into the home
- This is the address to which your mail is delivered
- This is your address on the electoral roll
- The property is connected to services and utilities (for example, phone, gas, or electricity)
- You show your intention in occupying the dwelling.
There is no minimum time that you have to live in a home before it can be considered to be your main residence. Even if you only own a house for a short period – six months, say – provided you tick all the boxes above, the property will be your main residence.
If you live on a large block, the CGT exemption normally only applies on land adjacent to the dwelling up to a maximum of two hectares. The main residence exemption also only applies to a property that includes a dwelling, which is anything used wholly or mainly for residential accommodation.
Examples of a dwelling are:
- A house or cottage
- An apartment or flat
- A strata title unit
- A unit in a retirement village
- A caravan, houseboat or other mobile home.
Simply owning land isn’t enough to claim the exemption, even if you intend to build a dwelling at a later date. However, you can choose to treat land as your main residence for up to four years before a dwelling is constructed in certain circumstances. You can choose to have this exemption apply if you acquire land and you:
- Build a dwelling on the land
- Repair or renovate an existing dwelling on the land, or
- Finish a partly constructed dwelling on the land.
There are a number of conditions you must satisfy before you can claim the exemption. You must first finish building, repairing or renovating the dwelling and then:
- Move into the dwelling as soon as practicable after it is finished, and
- Continue to live in the dwelling as your main residence for at least three months after it becomes your main residence.
CAN I HAVE MORE THAN ONE MAIN RESIDENCE?
You can only ever have one main residence at any given point in time. The exception is if you’re selling your old property and buying another. In this case you’re entitled to an overlap period of six months when both properties can be your main residence as long as:
- The new property will be your main residence after the sale of the old property
- You lived in the old property for at least three continuous months in the 12 months prior to sale, and
- The property wasn’t used to generate rental income in any part of the 12 month period that it wasn’t your main residence.
WHAT IF I CAN NO LONGER LIVE IN MY MAIN RESIDENCE?
The main residence exemption can also apply where the owner is no longer able to reside in the dwelling, because they have lost the ability to live independently and require full time care. This ensures property owners who spend an extended period in hospital, or must relocate to a residential care facility, or who relocate to live with a caregiver, can still access the main residence exemption when they sell the property to pay living and medical expenses.
CAN I EARN RENTAL INCOME FROM MY MAIN RESIDENCE?
You do not need to live in the dwelling for the entire period of ownership for it to continue to qualify for the exemption.
If you own a property which is currently your main residence you can move out of the property for up to six years and still get the exemption provided no other property becomes your main residence during the absence.
During that time you can earn rental income on the property and claim a tax deduction for expenditure as you would with a normal investment property. Providing you move back into the property before the end of the six year period and do not dispose of the property within the same financial year that the property was earning rental income you can still qualify for the full exemption.
DOES THE MAIN RESIDENCE APPLY TO PROPERTY RENOVATORS?
Yes, it does – provided you actually occupy the renovated property as your main residence, even if only for a short period.
If you purchase a property, occupy the dwelling while you are renovating it and then sell the property, any profit you make on the sale of the property is generally tax exempt, even if you then move into another property and repeat the process.
DOES IT MATTER IF I HAVE USED MY HOME TO EARN INCOME?
Some people use their home to produce income, either by renting out part or all of the property, or by running a business from home. If you tick one of those boxes, you may be forsaking part of your CGT exemption. This is because you can’t typically obtain a full main residence exemption if you used any part of your home to produce income during all or part of the period you owned it.
People who simply work from home as part of their job (such as teachers who might do some marking in the evening or anyone else who might do a bit of overtime away from the office) are not affected.
If you are impacted by the exemption, either you or your accountant will need to calculate how much of the profit on disposal of your house is taxable. In most cases, this is the proportion of the floor area of the home that is set aside to produce income and the period the home was used to produce income.
Here are some simple case studies to understand exactly how this works:
RUNNING A SMALL BUSINESS
Greg runs an IT consultancy from home as a sole trader, in addition to his day job working in IT for a major corporation. He undertakes projects working largely in the evenings and at weekends and converts a spare bedroom in his three bedroom house into an office where he runs his business.
He bought his house in 2006 for $500,000 and sells it in 2016 for $1,000,000. He estimates that approximately 10% of the floor area of the house is used in his home-based business. He commenced the business in 2011.
Ordinarily, the $500,000 profit on sale of his house will be exempt from CGT. However, for five years of the ownership period, he used 10% of the property to earn assessable income. This means that $500,000 x 10% x 50% of the gain ($25,000) will be taxable.
RENTING A ROOM THROUGH AIRBNB
Jill bought a three-bedroom apartment in Sydney in 2010 for $400,000. To help pay the bills, in 2014, she rented out one of the bedrooms through Airbnb. She estimates that including access to shared areas like the lounge and kitchen, 40% of the floor area is given over to earning assessable income through Airbnb. In 2016, she sells the apartment for $800,000.
Ordinarily, the $400,000 profit on sale of the apartment will be exempt from CGT. However for two years out of the six-year ownership period, she used 40% of the property to earn assessable income. This means that $400,000 x 40% x 33% of the gain ($52,800) of the gain will be taxable.
RENTING OUT THE WHOLE HOUSE WHILST TEMPORARILY WORKING AWAY FROM HOME
Bob bought a house in Perth for $500,000 in 2005. In 2012, he was employed to work in the mines in a remote area of Western Australia. He was provided with rental accommodation in that remote area by his employer. Whilst away, he rented out his whole house in Perth. In 2016, he sold the house for $1,000,000.
Ordinarily, the $500,000 profit on sale of the house will be exempt from CGT and that is indeed the case here. Tax law allows you live away from your home and earn assessable income from renting it out for up to six years (the six year absence rule) without losing the main residence exemption, provided you don’t acquire another main residence in the meantime. As Bob lived in rented accommodation whilst absent, he can take advantage of the six year rule and claim a full exemption from CGT on the sale.
RENTING OUT THE WHOLE HOUSE AND BUYING ANOTHER
Amy bought an apartment in Melbourne for $300,000 in 2010. In 2012, she took a job in London and moved overseas, renting out her Melbourne apartment. Shortly after moving to London, she bought a new flat in the city and has lived there ever since. She has no intention in the short term of moving back to Australia and accordingly, sells the Melbourne apartment in 2016 for $600,000.
Ordinarily the $300,000 profit on sale of the apartment will be exempt from CGT but that is not the case here. Amy cannot take advantage of the six-year rule since she acquired a new main residence (the fact that it was overseas is not relevant). Accordingly, she can claim the main residence exemption for the period she lived in the apartment (2010 to 2012) but not the period since she acquired the London apartment (2012 to 216). $200,000 of her profit will be liable for capital gains tax.