Strategies to Avoid Taxes on the Sale of Your Rental Property

Selling a rental property can bring significant financial gains, but it also opens the door to substantial tax implications. For property investors, understanding and navigating the complexities of tax liabilities upon the sale of an investment property is crucial. The difference between a profitable sale and a diminished return can often lie in the strategic planning and tax minimisation techniques employed before listing the property. This introduction sets the stage for exploring effective strategies that can help investors retain more of their hard-earned profits by reducing tax liabilities.

Understanding Capital Gains Tax

What Is Capital Gains Tax?

Capital Gains Tax (CGT) is levied on the profit realised from the sale of a non-inventory asset that was higher in value at the time of sale than when it was purchased. For property investors, this tax is a significant consideration, impacting the net return on investment properties.

How Capital Gains Tax Applies to Rental Properties

When selling a rental property, the difference between the sale price and the purchase price, minus applicable expenses, constitutes the capital gain subject to tax. This tax can considerably reduce the profit margin from the sale, making understanding and planning for CGT critical for investors aiming to maximise their returns.

Utilising the Main Residence Exemption

Qualifying as Primary Place of Residence (PPOR)

If you and your family have lived in a property since you bought it, if it’s not been used to generate income, and if it sits on land measuring two hectares or less, you’ll likely be fully exempt from CGT.

Even if you move yourself and your belongings, and change your address on the electoral roll, your former property can still maintain this status as long as it’s not used to generate income.

The 6-Year Rule and Its Benefits

Understanding the 6-Year Rule

The 6-Year Rule is a vital aspect of Australian property tax law, offering a way for investors to potentially avoid Capital Gains Tax (CGT) on a former principal residence that's been rented out. If you move out of your home and rent it out, the 6-Year Rule allows you to treat the property as your main residence for up to six years in terms of CGT, provided you don't claim another property as your primary residence during this period.

This rule is particularly appealing for property owners who might be relocating for work, traveling for an extended period, or simply investing in another property. The exemption applies to the entire period the home is rented out, up to a maximum of six years, allowing significant flexibility in property management and investment strategies.

Investing in Another Property

Reinvesting to Defer Capital Gains

Reinvesting the proceeds from the sale of a property into another investment property can be a strategic way to defer or reduce capital gains tax, depending on your jurisdiction's tax laws. This strategy requires understanding specific tax provisions that may allow for deferment or exceptions based on reinvestment.

Choosing the Right Investment

Selecting the next investment property involves analysing market trends, location potential, rental yield forecasts, and long-term growth opportunities. It's crucial to consider your investment goals, risk tolerance, and how the property fits into your broader portfolio strategy. Doing due diligence, including comprehensive market research and possibly consulting with a real estate investment advisor, can help ensure that your next investment aligns with your financial objectives.

For a detailed exploration of these strategies, including case studies and specific advice, consulting with a financial advisor or tax specialist is recommended. They can provide guidance tailored to your situation, helping to navigate the complexities of property investment and tax planning.

In Australia, property investors can reduce taxable gains through depreciation and capital works deductions. Depreciation allows investors to deduct the decline in value of assets within the property, such as fixtures and fittings, over time. Capital works deductions relate to construction costs of the building itself, including renovations, which can be written off over a period, typically 25 to 40 years. Utilising these deductions requires understanding specific eligibility criteria and maintaining accurate records to substantiate claims, effectively lowering the taxable income derived from investment properties.

Other Tax Strategies

Temporary Absence Rule

If you rent out a property you no longer live in, you’ll be able to continue having it as your main place of residence for up to six years, but you will only receive a part exemption from CGT.

During this period, you cannot treat any other property as your main residence, except for brief periods if you’re moving to a new home.

Have the Property Newly Assessed

As capital gain is calculated from the difference between your final sale price and the property value at the time your property was rented, organising a valuation before you rent out your property can give you a new cost base from which you can derive any future capital gains.

Take Advantage of the 6-Year Rule

Renting out your property for 6 years or less can leave you fully exempt from CGT, as long as you don’t treat another property as your main place of residence.

These 6 years don’t need to be consecutive.

SMSF Home Loan

If you bought your investment property through a self-managed super fund home loan at least 12 months ago, you’ll be entitled to generous tax benefits.

These include further discounts of a third if your sale occurs during the accumulation phase, and if you sell during the pension phase you won’t be liable for any CGT.

Increase your Cost Base

A property’s cost base is the cost of its acquisition, holding and disposal.

This number is subtracted from the property’s selling price to calculate your capital gain.

You can increase your cost base by including stamp duty, conveyancing fees, loan application fees and the cost of renovations. All of these costs quickly add up.

It’s important that you record all property-related expenses to help you in your calculations.

Wait until the Property has been Owned for a Year

Holding onto a property for longer than 12 months will reduce your CGT by discount or indexation. We have already explored the 50% discount applied to such properties.

Indexation is somewhat more complex and only applies if you acquired property before 21 September 1999.

Through indexation, you can convert your property’s original cost into today’s value.

Sell during a Year when Your Income Declines

If you know you’ll have a lower income in the next financial year, hold off on your sale until then to lower your marginal tax and your CGT.

The Date of Purchase

If you bought or acquired your investment property before 20 September 1985, you will not need to pay capital gains tax when it comes time to sell.

You also won’t need to pay tax on any profits, and you won’t be able to reduce your assessable income with any losses.

For all the above strategies:

• Ensure accurate scheduling of depreciation and capital works to maximize deductions.
• Keep detailed records of all costs associated with property improvements and purchases.
• Consult with a tax professional to accurately calculate and claim these deductions.

‍

Real Estate Agent Commission - Another Way To Save When You Sell

If you’re selling a rental property, the strategies in this post are a great way to lower the tax you have to pay for capital gains. Another great way to net more when you sell an investment property is to work with an agent that will reduce their commission rate.

At Minty, we’ve negotiated rates with over 1,000 top agents around Australia, and they will list your home for just 1%. That fee is only paid if the home sells, and we’ve helped thousands of sellers sell their home and save to date.