What Happens When Your Rental Property Becomes Main Residence?
If you’re a property investor looking into turning your investment property into your primary residence, there could be some tax benefits you might not be aware of.
For example, you could be eligible for partial exemption from your capital gains tax (CGT) liability. But are you still allowed to claim rental property tax deductions?
There are a few different scenarios when your rental property becomes your main residence, and each one will impact your tax obligations and access to potential benefits.
So, here’s what you need to know.
Turning Investment Property into Primary Residence
There could be various reasons why you would want to turn your rental property into your primary place of residence.
For example, your property investment could be negatively geared with negative cash flow, and to save on costs, you may be considering turning your investment property into your primary place of residence.
Or, perhaps you’ve been following a rentvesting strategy (where you own an investment property but rent your home) and have now decided that you no longer want to rent and would prefer living in a property you own.
Either way, for tax purposes, you’ll need to inform the Australian Tax Office (ATO) that you’re no longer generating income from your property because your rental property has become your main residence.
Turning investment property into a primary residence has a beneficial impact on your capital gains tax liability, but unfortunately, you’ll no longer be allowed to claim rental property tax deductions.
How Will the Capital Gains Tax Be Calculated?
While property investors are liable to pay capital gains tax on the eventual sale of their investment property, an individual’s primary place residence is usually exempt from CGT.
This is because homeowners don’t generally produce assessable income from their main residences, so the ATO exempts them from paying capital gains tax on the sale of their home .. where it has been their home for the entire period of ownership.
To prove to the ATO that a property is your primary place of residence (PPOR), you will have to:
- live in the property
- change the address on the electoral roll
- change drivers licence address
- keep your belongings there,
- use the property’s address to receive your postal mail and on the electoral roll, and
- have all the utilities connected in your name.
So, regardless of if the property was once used for investment purposes, at you’re living in your investment property with the intention of having the property be your primary place of residence, then you’ll qualify for a partial capital gains tax exemption .. for that period of time. This is if you have not nominated another property as your main residence for that period of time. The ATO only allows the MR exemption to apply to only one property.
If you would like to find out more about CGT exemptions, make sure to check out our guide on capital gains tax for property investments.
What About Rental Property Tax Deductions?
Unfortunately, while you can minimise paying CGT on the eventual sale of your investment property (turned into your main residence), you can no longer claim rental property tax deductions such as:
- interest on your home loan,
- rates and taxes, and
- property management fees.
This is because you’re no longer generating an income now that the rental property has become your main residence, and the ATO doesn’t allow you to claim on expenses incurred from managing your own home.
What Are The Tax Consequences for Partially Renting Out Your Main Residence?
Another option that some property investors end up considering, for various reasons, is turning their investment property into their primary place of residence while still renting out a portion of the property.
This might be the case if you have an extra room and you need to generate some extra income.
In these scenarios, the ATO allows you to apportion the property expenses you incur and claim some tax deductions. For example, you can claim tax-deductible expenses that you incur from renting out a single bedroom.
In July 2020, Ava chose to have her rental property become her main residence after three years of using it to generate an income.
Because the property is a three-bedroom home, and she doesn’t necessarily need all that space, she decided that it would be wise to generate some income from the property instead of wasting the space.
So, from November 2020, she leases out one bedroom to Charlotte with an en-suite bathroom. The floor area of the bedroom and bathroom makes up one-eighth of the property’s area.
Now that the end of the financial year is approaching; Ava wants to establish what tax-deductible expenses she can claim.
The total annual expenses for the property amounted to $7,200.
To calculate the expenses that she can claim as a tax deduction, Ava needs to apportion them according to the amount of space that Charlotte rents out and the duration that she’s used the space to generate income:
[$7,200 x 12.5% (floor space of the bedroom and bathroom)] x 8 months = $600.
So the total expense amount that Ava can claim as a tax deduction is $600 (one-eighth of the apportioned expenses).
You must apportion these tax deductions accurately, so you should contact a property tax agent who can help you.
Capital Gains Tax
The same will apply to capital gains tax if you sell your main residence after renting out a portion of it.
According to the ATO, if you’ve used any part of your home to produce income, even if it’s just a single bedroom, you’re generally not entitled to claim the full CGT main residence exemption.
To calculate the capital gain that is not exempt, you’ll need to consider several factors, including:
- the proportion of the floor area that is set aside to produce income – in other words, how big is the single bedroom compared to the rest of the property that’s not rented out,
- how long you rented out a portion of your PPOR,
- whether you’re eligible to claim the capital gains tax six-year rule, and
- whether it was first used to produce income after 20 August 1996.
If you’re thinking about turning your investment property into your main residence, you’ll need to weigh up the tax benefits and potential implications.
In cases where the rental property becomes main residence, you may qualify for a CGT exemption, but you will no longer be able to claim rental property tax deductions.
And, if you decide to rent out part of your principal place of residence, you’ll need to apportion your capital gain according to the amount of space you used to generate income and apportion your expenses according to the floor area of the space rented out.
So, there’s a lot to consider.
In either scenario, you’ll want to engage an expert tax agent to help you comply with your property tax obligations and take advantage of certain tax minimisation strategies.
Many Australians have built considerable wealth from property, and it remains a popular asset class for investors. But it can be tricky to navigate the complexities of property tax and regulations on your own. At Property Tax Specialists, our primary focus is helping property investors maximise their opportunities and legally minimising their tax liabilities while protecting their assets.
To discuss any matter relating to turning your rental property into your primary residence, capital gains tax, or tax-deductible expenses, get in touch today.
“This information has been prepared without taking into account your objectives, financial situation or needs. Because of this, you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs”.
Amir Ishak is a Limited Authorised Representative 1269908 of Merit Wealth Pty Ltd, Australian Financial Services Licence 409361, ABN 89 125 557 002