Are you considering making the leap from landlord to resident? Before you stop collecting rental income and settle into your investment property or holiday home as your cozy primary abode, it’s crucial to understand the financial implications. This transition can be thrilling but challenging, from taxation and capital gains tax to the long-term effects on your investment strategy.
At First Financial, we specialise in helping our clients retire life-ready, including advising on the financial consequences of moving into an investment property or holiday home. Here’s what you need to know to make an informed decision and navigate the nuances of turning your profit-generating asset into your personal haven.
Tax implications of converting an investment property to a primary residence
Converting an investment property or holiday home to your primary residence involves several tax implications, especially concerning Capital Gains Tax (CGT). While your primary residence is usually exempt from CGT, you might still be liable to pay CGT proportional to the period the property was rented out if & when you eventually sell the property.
Understanding these tax implications can help you plan effectively and maximise your financial benefits. Keeping detailed records of your expenses, improvements and periods of occupancy ensures you and your financial adviser have all the information needed for optimal decision-making.
What you need to know about CGT
Capital Gains Tax (CGT) applies to the profit made from selling assets like real estate. If a property was once an investment, it likely gained value, and you can’t avoid CGT on that profit. Even if it becomes your primary residence, any profit from its investment period remains taxable. Here are the key points to consider:
- Initial Exempt Period: If disposing of an old primary residence after you’ve already moved into a new primary residence, the government provides a 6-month overlap period where you can claim the main residence exemption for both properties, given certain conditions are met. Use this window wisely.
- Pro-Rata Calculation: Should you decide to sell the property down the line, only the period during which it was your main residence will be eligible for the CGT exemption. The time it spent as an investment will still count towards your CGT liability.
- The Six-Year Rule: Under the six-year rule, if you rent out your former primary residence, you can treat it as your main residence for up to six years for CGT purposes. This rule can provide significant tax relief under the right circumstances.
With the right knowledge and strategy, managing Capital Gains Tax becomes a more manageable part of your financial planning, allowing you to optimise your portfolio effectively.
An example of partial CGT relief
The following scenario illustrates how living in a previous rental property can provide partial relief from CGT when it’s time to sell.
John and Grace purchased an investment property worth $600,000 a decade ago. Over the years, they used the property as a rental for seven years and then moved in, making it their primary residence for the remaining three years. They recently decided to sell it to fund early retirement and move to a retirement village, with the property now valued at $1.2 million.
Since they lived in the property as their primary residence for three out of the ten years, 30% of the gain—equivalent to $180,000 (30% of the $600,000 gain)—will be exempt from CGT. The remaining 70% of the gain, amounting to $420,000, will be subject to the standard CGT calculations.
Talk to the retirement planning experts
Are you considering moving into your investment property or holiday home? Have you weighed the personal and financial benefits of such a move? While it can seem like an ideal solution, it’s crucial to evaluate the overall impact this may have on your financial landscape.
At First Financial, our experienced team can provide the clarity necessary to make informed decisions on your investment matters. We understand the impacts of Capital Gains Tax (CGT) and other long-term effects on your investment portfolio. By navigating these complexities, we help you avoid unintended financial consequences and secure your financial future.
Contact a friendly member of our team today to learn more about our investment philosophy, investment management or retirement planning services.
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