Did you find working from home during COVID-19 lockdown to be a success? Are you considering giving up your leased commercial business premises to instead run your business from home? This choice may result in the Australian Taxation Office taking a slice of the capital gain that you make when you eventually sell your home. What are the Capital Gains Tax implications of a home based business.
Tax Tip: If you have been using your home to run your business and are considering selling it, speak to your accountant before you sign a contract to sell so you have the best chance to minimise any capital gains tax (CGT) on the sale.
- Do you run a home-based business?
When you operate a home-based business and you have set aside part of your home exclusively for the purpose of conducting your business activities, your home is your principal place of business and you may be entitled to claim a Tax deduction for both business related occupancy expenses and running expenses.
Examples of businesses operated from home include:
- a doctor or a dentist who run their surgery or consulting room at home
- a small business operator who operates their main office in their home
- a tradesperson or craftsperson who operate their workshop at home
Note: If you only do some business or work from home, in either a specific work area or another part of your home, it may not qualify as a place of business, however you might be eligible to claim only additional working from home related running expenses.
- Deductions you may claim when your home qualifies as your principal place of business:
If you operate some or all of your business from home, you may be able to claim tax deductions for the business portion of expenses.
These may include:
- occupancy expenses (such as mortgage interest or rent, council rates, land taxes, house insurance premiums)
- running expenses (such as electricity, phone, decline in value of plant and equipment, furniture and furnishing repairs, cleaning)
- the cost of motor vehicle trips between your home and other locations, if the travel is for business purposes.
You may not be able to claim occupancy expenses if personal services income rules (PSI) apply to your business.
You can claim both occupancy expenses and running expenses if you have an area of your home set aside as a ‘place of business’.
Remember, if your business is entitled to goods and services tax (GST) input tax credits, you must claim the deduction in your income tax return at the GST exclusive amount.
You may be eligible for an immediate deduction or an accelerated rate of decline in value for depreciating assets under one of the tax depreciation incentives, such as temporary full expensing.
- Home-based business and CGT implications
Generally, when you sell your home CGT doesn’t apply. However, if you used any part of your home for business purposes, you may have to pay CGT.
CGT won’t apply if any of the following occurred with your home-based business:
- You operated your business from a rented home
- You didn’t have an area specifically set aside for your business activities
- You operated your business through a company or trust
CGT Rule: You only have to pay CGT for periods when you used your home for your business.
For example, if you owned your home for 10 years, but only used it for business in the last two years, then you only need to pay tax on the capital gain in the last two years.
In most cases, the percentage of the capital gain that is taxable is the same as the percentage for which you could claim a deduction for mortgage interest. This is generally based on the floor area of your home you have set aside for business, for example 10%.
Tax Tip. You may be able to apply one or more of the small business CGT concessions to reduce your capital gain unless the main use of the house was to produce rent.
How it works
If you rent out part of your home or run a business from home, you do not get the full main residence exemption from capital gains tax (CGT).
When you sell your home, the part you used for rental or to run a business is subject to CGT.
You can usually claim income tax deductions for that part of your home because it has been used to produce assessable income.
To work out your assessable capital gain or loss, you take into account:
- the proportion of the floor area that was set aside for rental or to run a business
- the period you used it for this purpose
- the capital gain or loss on your home since you first started using it for rental or business, assuming this was after 20 August 1996. If it was before this, you use the gain or loss since you acquired your home.
Tax Tip: It is a good idea to get your home valued when you first start using it for rental or business. You’ll need to know this value later when you sell it.
If you move out of your home and rent it out, you can continue treating your former home as your main residence for up to 6 years. However, you can’t claim a main residence exemption for any other property for the same period.
- Check whether CGT applies – the interest deductibility test
You may not be entitled to a full main residence exemption if you use part of your home for producing assessable income. If you pass the interest deductibility test you will have some assessable capital gain.
The test is, if you had borrowed to acquire the home would you be allowed a tax deduction for part of the home loan interest. If you would be eligible to claim part of the interest expense your home is subject to CGT to the same extent.
If you have a home loan you cannot reduce the capital gain by not claiming some or all of the interest, nor can you increase the cost base of your home by the amount of interest you choose not to claim.
You can still get a full main residence exemption if someone else uses part of your home to produce income and you receive no income from that person for the use of the property.
Running a business from home
You are running a business from home if it is your principal place of business and you have a space set aside just for this purpose. Merely working from home occasionally does not qualify.
You would be entitled to deduct part of any home loan interest if:
- part of your home is set aside exclusively as a place of business and is clearly identifiable as such
- that part of the home is not readily adaptable for private use – for example, a doctor’s surgery located in a doctor’s home.
You would not be entitled to deduct interest expenses if, for example:
- you use a home study to do work usually done at your place of work
- you do paid child-minding at home (unless a special part of the home was set aside exclusively for that purpose).
If you are not entitled to deduct interest expenses you are eligible for the full main residence exemption.
- Work out the assessable part of your capital gain or loss
You can use the CGT property exemption tool to calculate the proportion of your home that is subject to CGT.
Alternatively, you can work out the assessable part of your capital gain or loss as follows:
Step 1: Work out the capital gain or loss on your home based on its value when you first used it to produce income.
- There are exceptions if you first used your home to produce income before 21 August 1996 or inherited your home. See Value of home when first used to produce income
Step 2: Determine the proportion of your home’s floor area that you set aside to produce income.
Step 3: Multiply steps 1 × 2. If you:
- used your home to produce income right up to when you sold it, this is your assessable capital gain or loss – you do not need to continue
- stopped using your home to produce income before you sold it – continue to step 4.
Step 4: Determine the number of days you used your home to produce income.
Step 5: Determine the number of days from when you first used your home to produce income until you sold it.
Step 6: Your assessable capital gain is step 3 × (step 4 ÷ step 5).
Example: Part of home used for income throughout ownership period
Thomas bought a house on 1 July 2000 for $300,000. He sold it on 30 June 2023 for $700,000. The house was his main residence for the entire time.
Throughout the period Thomas owned the house a tenant rented one bedroom, which represented 20% of the house. Both Thomas and the tenant used the living room, bathroom, laundry and kitchen, which represented 30% of the house. Only Thomas used the remainder of the house. Therefore, Thomas would be entitled to a 35% deduction (20% + (30% ÷ 2 people) for home loan interest (if he incurred it).
Using the steps above, Thomas works out his assessable capital gain as follows.
- Thomas used his home to produce income from the time he acquired it. Therefore he uses its initial value to work out his capital gain:
$700,000 − $300,000 = $400,000. - The proportion of the floor area set aside for rental is 35%.
- Thomas’ assessable capital gain is $400,000 × 35% = $140,000. As he used his home for income right up to when he sold it, he does not need to apportion the time it was used to produce income.
As Thomas owned his house for at least 12 months he can use the CGT discount (50% for individuals) to reduce his capital gain. Therefore, Thomas’s assessable capital gain would be $70,000.
Example 2: Part of home used for income for part of ownership period
Fatima bought a house in December 1995 for $200,000. It was her main residence.
- On 1 November 2015 she started to use 40% of the house for a consultancy business. At that time the market value of the house was $520,000.
- On 1 August 2019 she shifted her consultancy practice to separate business premises and once again used her home solely for private purposes.
- On 1 May 2023 she sold her house for $620,000.
Using the steps above, Fatima works out her assessable capital gain as follows.
- Her capital gain based on the value of her home when she first used it to produce income is $620,000 − $520,000 = $100,000.
- The proportion of her home’s floor area set aside for business was 40%.
- $100,000 × 40% = $40,000. As Fatima stopped using her home for business before she sold it, she continues to step 4.
- Fatima used her home to produce income from 1 November 2015 to 1 August 2019, a total of 1,370 days.
- The period from when she first used her home to produce income until she sold it is 2,739 days.
- Fatima’s assessable capital gain is $40,000 × 1,370 ÷ 2,739 = $20,007.
For CGT purposes, Fatima is taken to have acquired the house on 1 November 2015. This is more than 12 months before she sold it, so she can use the CGT discount (50% for individuals) to reduce her capital gain. Therefore, Fatima’s assessable capital gain would be $10,003.
- Value of home when first used to produce income
If you use your home to produce income you are generally taken to have acquired it at the time you first used it for this purpose.
This means when you sell your home, you work out the capital gain or loss using its market value at the time you first used it to produce income.
- It is called the ‘home first used to produce income rule’.
- If you sell your home within 12 months of when you first use it to produce income you cannot use the CGT discount.
Exclusions
If you:
- use your home to produce income from the time you acquire it, the rule does not affect you – for example, see Rental property becomes your main residence
- inherit a dwelling that was the deceased’s main residence – the rule does not apply if you sell the dwelling within 2 years
- choose to continue treating a property as your main residence after you move out – if the property is fully exempt, the rule does not apply.
Example – ‘Home first used to produce income rule’ does not apply in some cases
Peter bought a house on 1 October 2010 for $550,000. He rented it out until 30 June 2013. Peter moved into the house on 1 July 2013 and lived in it for the entire period until it was sold on 30 March 2023 for $780,000.
The ‘home first used to produce income rule’ does not apply as the house was rented from the time Peter acquired it. This means that Peter is not required to use the market value of the house at the time it was first used to produce income. Peter will work out the capital gain based on the cost base of $550,000. Peter is entitled to the main residence exemption from 1 July 2013 to 30 March 2023 (3,560 days).
The assessable part of Peter’s capital gain will be calculated as follows:
- Capital gain for the entire period is $780,000 − $550,000 = $230,000
- Peter’s home was rented out for 1,004 days (1 October 2010 to 30 June 2013)
- Peter’s total period of ownership was 4,564 days.
- Capital gain for the period that was rented out is $230,000 × (1,004 ÷ 4,564) = $50,577.
- Peter is entitled to the CGT discount of 50% which will reduce his capital gain. This means Peter’s assessable capital gain would be $25,288.
When the rule applies
Apart from the exclusions above, the rule applies if all of the following are true:
- you acquired the property on or after 20 September 1985
- you first used the property to produce income after 20 August 1996when you sell the property (or another CGT event happens to it), you would get only a partial CGT exemption because you used it to produce income during the period you owned it
- you would have been entitled to a full exemption if the sale or other CGT event happened to the property immediately before you first used it to produce income.
How can we help?
If you have any questions or would like further information or you are seeking property tax advice, please feel free to contact our office via email –info@investplusaccounting.com.au or phone 02 9299 7000 to either speak with someone or arrange a time for a meeting so we can discuss your requirements in more detail. You can arrange a free 15 minute no obligation chat to discuss your options. Please arrange an appointment with our office by clicking here
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