Taking in a tenant or running a business from a room at home both earn income from the place you live. For capital gains tax, that can mean part of a later gain on the home is taxable. This guide explains the general rule, what the ATO looks at, and where a valuation fits.
When does earning income from your home affect the exemption?
Section 118-190 of the Income Tax Assessment Act 1997 gives only a partial exemption where a home was used to produce assessable income and you could have deducted some of the interest on money borrowed to buy it. The ATO calls this the interest deductibility test, and says it applies even if you have no home loan: if you would be able to claim part of the interest, your home is subject to capital gains tax to the same extent.
Common cases:
- Renting out part of your home. The ATO says you can claim a deduction for the home loan interest on the rented portion, and the gain on that portion for the rental period is assessable, for example the floor area used by tenants.
- A business run from home. This affects the exemption where your home is your principal place of business and part of it is set aside exclusively for the business and is not readily adaptable for private use, such as a doctor’s surgery in the doctor’s home.
- Working from a home study. The ATO says a home study used for work you would usually do at your workplace does not give an interest deduction, and nor does paid child-minding at home unless part of the home is set aside exclusively for it.
The ATO also says you can still get the full exemption if someone else uses part of your home to earn income and you receive no income from them for the use of the property.
How is the taxable share worked out?
The ATO’s method looks at three things: the share of the floor area used to earn income, the period it was used that way, and whether that use started after 20 August 1996. Areas shared with a tenant, such as a kitchen or bathroom, can count in part. In the ATO’s example, a tenant rented a bedroom that was 20 per cent of the house and shared the living room, bathroom, laundry and kitchen, another 30 per cent, with the owner. Counting half of the shared areas, the rented share came to 35 per cent.
If the income use started after 20 August 1996, and the home would have been fully exempt if sold just before then, you are generally treated as having bought the home on the day it was first used to produce income, at its market value then (section 118-192). The ATO’s steps start from that value: the gain from the home’s value on that day, times the share of floor area and, if the income use stopped before the sale, a share of the time.
Your accountant does the calculation and decides which rules apply.
What about the six-year rule?
If part of your home was used to produce income before you moved out, the ATO says you cannot apply the absence rule to that part, either before or after you stop living there. The rest of the home can still be covered. See the six-year rule.
Granny flat arrangements are different
A formal granny flat arrangement is a written agreement that gives someone the right to live in a property for life. The ATO says capital gains tax does not apply when an eligible arrangement is created, varied or ended, as long as it is not commercial in nature. Other events, such as a later sale of the property, follow the normal rules. That is a separate rule from renting out part of your home, so ask your accountant which applies.
Which records should you keep?
The ATO says to keep records of the expenses while the home earned income, and of the proportion of the property used to produce it. If the income use started after 20 August 1996, it says to keep a record of the home’s market value at the time it was first used to produce income. Its guidance is to get a market valuation at the time, and it says you can arrange one later if necessary.
Records that help:
- a floor plan or sketch showing the rented or business area, with rough measurements
- leases or rental agreements, with dates
- when a business started and stopped using the space
- photos of the home and the space from around the date it was first used to earn income
- dated invoices for any work to create the space, such as a new bathroom for a tenant
See records to keep for the rest.
Where a valuation fits
A valuation may be useful when the home first used to produce income rule applies. It states what the home was worth on the day part of it was first used to produce income, and the ATO’s steps start from the whole home’s value on that day. See valuing part of a home for how we handle these requests.
The Desktop CGT Valuation is $149 and the Inspected CGT Valuation is $495, both including GST. Short answers are on our questions page, and the glossary explains terms such as the interest deductibility test.
We value property. We do not give tax advice. Your accountant decides how the main residence rules apply to your home.