Capital gains tax: Will Aussies trying to save money cop a sneaky tax blow for renting a spare room?

Many Aussies are renting out their spare rooms to make ends meet but could it end up costing them?

As the cost-of-living crunch continues to hit household budgets, many are considering the option of renting out a room in a desperate bid to bring in more cash.

One Yahoo Finance reader, feeling the pinch, is keen to jump on that train but is unsure of the potential capital gains tax (CGT) implications, and whether they might actually end up losing out financially.

So, here's a breakdown of how CGT works and what it might cost you to take in a tenant.

Compilation image of Arial view of property and an ad for renting rooms with a red ring for article on capital gains tax implications
Earning an income through your primary residence means it's no longer exempt from capital gains tax. (Source: Yahoo Finance AU)

What is CGT and how does it work?

CGT applies to the disposal of capital assets, such as property, shares or business assets. For many people, the most valuable CGT asset they own is their home. However, the government recognises that applying CGT to family homes is unfair and they are therefore usually exempt, by applying the so-called “main residence exemption”.

Do you have to pay CGT if you rent out your spare room?

Unfortunately, yes, CGT could apply to the disposal of your otherwise-exempt main residence if you are renting out part of it. The exemption does not apply if part of the home is used to produce assessable income: for example, part of it is rented out or used to run a business.

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Therefore, although you will still get a partial exemption on the part of the home that is not being used to produce assessable income (the part you are actually living in), you will have to pay CGT on any part of the profit that relates to the part of the house, in this case, that is rented out.

Here’s an example of how much CGT you might be subject to

If, for example, the renter has sole use of a bedroom and bathroom (which is 10 per cent of the floor area) and you share equally the use of the living room and kitchen (which is another 25 per cent of the floor area). This means that, when you come to sell the property, 22.5 per cent (10 per cent + half of the 25 per cent) of the profit will be subject to CGT at your marginal rate.

You may be able to claim the 50 per cent CGT discount if the lodger has occupied the rooms in the house for more than one year.

Are there any instances where you can avoid paying CGT?

In situations where you have someone (usually a family member) living with you and they are either not paying rent or they are paying only a token amount of 'board' (for example, where you have children or a parent living with you and they simply pay a contribution to the upkeep of the house, say $50 a week), this is not assessable income and, therefore, the CGT exemption is still available for the whole property.

Really, in order to understand the impact on the main residence exemption, you need to focus on the difference between a commercial rental agreement with a third-party tenant (which will jeopardise the CGT main residence exemption) and a purely private, domestic situation where you have a child or other relative living with you, paying non-commercial 'board' or nothing at all.

If you are affected, a special rule known as the “first use to produce income” rule, may apply. This means the tax office “resets” the tax cost of the home to its market value at the date that it was first rented out - which replaces its original purchase cost and acquisition date.

Therefore, when you first rent out your property, you may need to get an independent valuer to value the property.

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