Two thirds of Australians live in an owner occupied family home, which is one of the highest rates of home ownership in the world.
For many home owners, it is the favourable tax treatment of the family home, as much as “living the Great Australian Dream”, that makes owning a family home so compelling.
This is a guide to the tax treatment of the family home.
What taxes apply to the Family Home?
Three main taxes apply to the family home –
1. Capital Gains Tax – is paid on the profit made when real estate is sold. Normally, the family home is exempt. If you don’t keep the family home exempt, then the capital gain – the sale price less the purchase price less purchase, sale and holding costs - will be added to your normal income in the year of sale and income tax will be payable. The capital gain will often put the taxpayer into a high tax rate bracket.
Illustration: if a property is sold and the capital gain is $100,000, assuming that other income is $85,000, then the income for tax purposes will become $185,000 and the extra tax payable will be $39,309.99 (≈ 40% of the capital gain).
2. Income Tax – is paid on rent. Owner occupiers who rent out a room in the family home or a garden flat need to add the rent received to their income, and pay tax on it.
Illustration: if the rent is $300 per week, then $15,600 is added to income.
3. Land Tax - is paid on the land value, annually. Normally, the family home is exempt. If you don’t keep the family home exempt, then land tax is payable calculated upon the land value. Note: land tax is calculated only on the land value, not the value of the land and the home.
Illustration: if the land value exceeds the land tax value threshold ($549,000 in NSW in 2017) then land tax of 1.6% (or 2%) (in NSW) is payable annually on the excess land value. Land Tax in each State is payable in a similar way.
Capital Gains Tax and the Family Home
The Australian Taxation Office (the ATO) calls the family home ‘a dwelling that is your main residence’. Any capital gain / profit received on its sale will be tax free because of the capital gains tax exemption for the family home, provided these requirements are mostly satisfied:
- you and your family live in it
- your personal belongings are in it
- it's the address your mail is delivered to
- it's your address on the electoral roll, and
- services such as gas and power are connected
These are the main rules which apply to satisfy the main residence exemption:
Rules for moving in and moving out
- You must move in as soon practicable after purchasing the family home. If you are building a new home or renovating, you must move in as soon as practicable after it is ready to occupy.
A common plan is to buy, rent out the new family home for a while, and move in later on. In this case, capital gains tax will apply to the increase in value in the period from the date you buy until the date you move in.
- You may move out and rent the family home for up to six years without losing the capital gains tax exemption, so long as you do not purchase another family home in the meantime. Before the six year period ends, you have the choice of either selling (if so, the sale proceeds will be tax free) or moving back into the family home (which will re-start the six year period).
- You may move out and leave the main residence vacant or allow a family member to live in it rent free. If so, you retain the capital gains tax exemption indefinitely.
- You have a crossover period of six months if you purchase a new home first and then sell your old home. During that period you can call both homes your main residence.
Rules for ownership and inheritance
- If your name is recorded as an owner on the property title, and if you occupy the home as your main residence, then the capital gains tax exemption applies to you. The exemption applies only if the home is in a personal name. If the family home is in the name of a company or a trust, you may have asset protection, but do not have capital gains tax exemption.
- If you own a family home and a holiday home jointly with your spouse, you cannot claim to live in both homes so as to enjoy a capital gains tax exemption for both homes. You can only have one home as your main residence.
- If you inherit a family home there is a time limit of two years from the date of death to sell it. Otherwise, capital gains tax will be payable on the increase in value from the date of death. If you choose to live in the home, you will have your own main residence exemption.
The two year time limit does not apply if the inherited home was purchased before 20 September 1985, then the home will retain its tax free status while it is owned by the beneficiary who inherits the home, whether the beneficiary lives in the home or not.
Rules for renovation and subdivision
- If you buy a house to renovate or build a house for a profit, when you sell, the whole of the profit may be treated either as ordinary income or as a capital gain. That is, the main residence exemption from capital gains tax might not be available even if you move in.
- If you subdivide land with a family home built upon it, the profit on sale of the family home will be capital gains tax exempt (if it is used as a main residence) while the profit on sale of the subdivided land will be treated either as ordinary income (if you bought to subdivide) or as a capital gain (if not).
Rules for capital gains tax liability
- If you own a property for more than 12 months as an individual, then only one half of the capital gain is added to your income (this is known as the 50% capital gains tax discount).
- If you acquired the property before 21 September 1999, you can choose to apply the CPI increase to the base value for capital gains tax, up to that date. If so, you can apply the 50% capital gains tax discount method from that date.
- If you acquired the property before 20 September 1985 – whether lived in or rented or vacant, the capital gain is tax free! Why that date? Capital gains tax was introduced on that date. You need to think twice if you are thinking of selling a pre 20 September 1985 property!
- If you sell a property, the date that the capital gain is treated as made (the ‘capital gains tax event’) is the date that the contract for the sale of the property becomes unconditional, not the settlement date when the sale proceeds are received.
Income Tax and the Family Home
A home office, a garden apartment, separate flat or spare rooms which are rented produces taxable income, but also results in a partial loss of the capital gains tax exemption.
- A home office use means that part of the home must be used exclusively as a place of business and is not readily able to be adapted for private use. Examples are a doctor’s surgery, a consultancy practice, a photographic studio, which members of the public can visit.
The positive is that interest paid on the home loan may be deducted from the business income for tax purposes, in the proportion that the floor area of the home office bears to the floor area of the home. The negative is that the capital gains tax exemption is partially lost in the same proportion for the period in which that part of the home is used as a home office.
- Permanently renting a garden apartment, separate flat or spare rooms in a family home which is owner-occupied is similar to having a home office in terms of rent being taxable income and a proportion of interest and utilities such as electricity and rates and insurance being tax deductions. Again, the capital gain is taxable, calculated on the proportion of the house rented for the period it was rented. On its website, the ATO notes that payments received from a family member for board or lodging are considered to be domestic arrangements and not rental income.
- The ATO treats renting a family home or spare rooms short-term through a sharing economy website or app, like Airbnb, Stayz or a rental agent, as being the same as permanently renting both for income tax purposes and for capital gains tax purposes. The ATO requires you to keep records of all income earned and declare it in your income tax return, and to keep records of expenses claimed as deductions. The capital gains tax exemption is lost in the proportion of the floor area rented out and the floor area of the family home, and the length of time it was rented (or was available for rent).
Land Tax and the Family Home
A land tax exemption applies to the family home, with similar rules to the capital gains tax exemption. The Land Tax Office calls the family home the ‘principal place of residence’.
These are some of the rules:
- There can only be one principal place of residence, within or outside of Australia. The residence must have a kitchen, bathroom and toilet facilities.
- The exemption applies only if an owner uses and occupies the residence during the land tax year. Because land tax is an annual tax, this requirement must be satisfied every year.
- Not all of the owners need to occupy the residence for it to be exempt. So long as one owner does, then their occupation will exempt the whole property from land tax.
- The exemption applies to the whole property, although part is used as a home office, or is rented as a garden apartment, separate flat or one or two rooms. The exemption also applies where a property has short-term lettings such as bed and breakfast accommodation, if an owner lives on site.
- A crossover period of 6 months applies when moving houses, during which both residences can be treated as a principal place of residence.
- A principal place of residence will retain its exemption for up to 6 years after the owner occupier has moved out, provided they do not own another principal place of residence.
Keeping the Family Home outside of the Centrelink assets test after retirement
On retirement, the family home acquires a new status – it is not included as an asset by Centrelink when applying the means test for age pension entitlements.
The sale of the family home can drastically reduce the age pension entitlement and the viability supplement for aged care.
These are some of the rules:
- The family home is exempt from inclusion in the assets test for age pensions, no matter what its value. A single home owner can hold up to $552,000 in assets (apart from the home) before the age pension cuts out, and a home-owning couple can hold up to $830,000 in assets.
- For non-home owners, the assets test limit is $203,000 higher. It is $755,000 for a single and $1,033,000 for a couple. This means that if the family home is worth more than $203,000, it is better to keep owning it, not selling it to free up cash.
- If the family home is sold and the proceeds of sale are not applied to buy a new family home or aged care accommodation within 12 months, then the proceeds of sale are counted as assets. If not all of the proceeds are applied, the surplus is added to the person’s assets.
- It is not possible to sell and give away the proceeds of sale to relatives because Centrelink will only count $10,000 per year (up to $30,000 in 5 years) of the gift as a reduction in assets. Centrelink does not prohibit proceeds of sale to be used to repay personal debt, to pay for home improvements, or to pay for personal holidays such as retirement cruises.
- Age pension recipients who are short of cash to pay expenses can take out a reverse mortgage, which enable retirees to access the equity in their home without selling it.
Conclusion: The Family Home is Australia’s favourite tax haven for good reason
Its tax exempt status makes the family home in Australia very valuable.
Coupled with the fact that there are no inheritance taxes in Australia, it makes perfect sense for Australians to buy a family home to live in and remain living in it as long as possible.