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 residential 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 residential accommodation) 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) in your return 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.

How Long Do You Need to Live in a House to Avoid Capital Gains Tax Australia?

To avoid paying capital gains tax on your main residence in Australia, you generally need to live in the property for the entire period of ownership. 

However, if your property was previously used as an investment before becoming your PPOR, you may still qualify for a partial CGT exemption for the period you lived there.

What is the CGT Main Residence Exemption?

The full main residence exemption is a tax provision that allows individuals to be exempt from having to pay tax when selling their main residence or PPOR. This exemption applies to: 

• The dwelling that is the main residence
• The land the dwelling is built on
• Up to 2 hectares of adjacent land used for private/domestic purposes

Essentially, if you sell your main home that you have lived in for the entire ownership period, you do not have to pay CGT on any capital gains made from that sale. However, there are certain conditions and limitations to qualify for the full exemption, such as using part of the property for income-producing purposes.

Do You Have to Live in a House for a Year Before Renting Australia?

There is no specific requirement to live in your property for a year before renting it out in Australia. However, if you purchase a property and immediately rent it out without living in it first, the property will be considered an investment property and will not qualify for the main residence CGT exemption. 

If you live in your property for a period of time then need to move out and start renting it out, you may be eligible for a partial main residence CGT exemption for the period you lived there. 

The length of time you need to live in the property to qualify for this exemption is not strictly defined, but the ATO will consider factors such as your intention when purchasing the property and the reasons for moving out. The ATO has the with the benefit of hindsight, as they will look at the transaction after the fact.

What is a PPOR? 

PPOR stands for “Primary Place of Residence” and refers to the main property you live in. Your PPOR is typically exempt from CGT in Australia, as it is not an income-producing asset, but there are rules. 

The ATO considers a property to be your PPOR if you and your family live there, keep your personal belongings there, and use the address for your mail and other official purposes like the electoral roll.

It’s important to note that you can only have one PPOR at a time.

If you move out of your main residence and rent it out, it may no longer qualify for the full CGT exemption. However, if you move back into the property and designate it as your PPOR again, you may be eligible for a partial exemption for the period you lived there.

To prove to the ATO that a property is your PPOR, you will need to:

• Actually live in the property
• Change your address on the electoral roll
• Update your driver’s licence address
• Keep your belongings at the property
• Use the property’s address for mail and on the electoral roll
• Have utilities connected in your name

Regardless of the property’s past use for investment purposes, if you’re currently living there with the intention of it being your main residence, you’ll qualify for a partial capital gains tax exemption for that period. 

This is contingent on not nominating any other property as your main residence during the same timeframe, as the ATO only allows the main residence exemption to apply to one property at a time.

Remember: The main residence exemption has some restrictions, such as only applying to properties on land under 2 hectares. 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.

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. 

Can I Still Claim Rental Property 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: 

• Depreciation, 
• Interest on your home loan
• Rates and taxes
• 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 principal 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. 

Tax-Deductible Expenses

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. 

Example: 

In July 2023, 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 2023, 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). Ava would also need to report the rental income on her tax return. 

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
• Whether it was first used to produce income after August 20, 1996.

This calculation could get very complex.

Key Takeaways

• 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 and deductions. 

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 minimise 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.

FAQs

Can You Have Two Primary Residences In Australia?

Generally, you can only have one primary residence at a time in Australia for tax purposes. However, there is a six-month rule that allows you to have two properties considered as your primary residence for up to six months if you acquire a new home before selling your previous one. To qualify, you must have lived in the old property for at least three months in the 12 months before selling it and not used it to produce assessable income during that time.

What Is The 6 Year Rule For Primary Residence?

The six-year rule allows you to maintain your primary residence exemption from Capital Gains Tax (CGT) if you move out of your main residence and rent it out for up to six years. To qualify, the property must have been your primary residence before being rented out. Each period you are away is treated individually, meaning the six-year rule resets each time you move back into the property. You cannot treat any other property as your main residence during the absence period unless applying the six-month rule.

How Do I Prove My Principal Place Of Residence In Australia?

To prove a property is your Principal Place of Residence (PPOR) in Australia, you should:

• Live in the property with your family
• Keep your personal belongings there
• Use the address for mail delivery and on the electoral roll
• Have utilities like gas and power connected in your name
• Update your driver’s license and other official documents with the address

The Australian Taxation Office (ATO) considers factors such as the duration of your stay and your intention to make the property your main home when determining if it qualifies as your PPOR.

Can a Foreign Resident Claim the Main Residence Exemption?

Generally, foreign residents are not entitled to claim the main residence exemption from CGT when selling their Australian property after June 30, 2020. However, there are some exceptions:

• If the foreign resident has been a non-resident for a continuous period of 6 years or less at the time of selling the property, they may still be able to claim the main residence exemption. This is provided that during that 6-year period, if certain “life events” occurred
• There are transitional provisions that allow foreign residents who owned their home before 7:30pm on May 9, 2017 to claim the main residence exemption, provided they sold the property on or before June 30, 2020.

If neither of these exceptions apply, a foreign resident at the time of selling their Australian property after June 30, 2020 will not be eligible for the main residence CGT exemption. This is regardless of whether the property was their main residence for part of the ownership period.

Please note that every effort has been made to ensure that the information provided in this guide is accurate at time of writing. You should note, however, that the information is intended as a general guide only, providing an overview of general information available to property buyers and investors. This is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.

Amir Ishak is a Limited Authorised Representative 1269908 of Merit Wealth Pty Ltd, Australian Financial Services Licence 409361, ABN 89 125 557 002