If homeowners aren’t under stress now, they will be soon. Eleven consecutive interest rate rises and more in the pipeline is dark news for homeowners nursing over-sized mortgages bid up from the recent property boom. So what can struggling homeowners do if mortgage repayments become too big to handle? Is their only recourse to sell their property and pay down their mortgage? A largely unused option might be just the answer. And that's to rent out your property. But most people prefer not to rent because when the time comes to sell up, any profits are subject to capital gains tax unlike the capital gains tax exemption applied on your principal place of residence. However that mightn’t be the case on all occasions. Indeed, the Australian Taxation Office allows capital gains tax exemptions for rential properties under specific circumstances. In other words, it’s possible to rent out your property for a certain period of time – and still sell it for a tax free gain. The handy part about renting out your property is that you can receive rent, and interest payments on your mortgage, any repairs and maintenance costs on the property as well as other fees may be tax deductible. The net effect is that these extra funds (rental income plus tax savings) can be channelled towards paying off your mortgage. Astute investors should be questioning the legitimacy of this strategy: how can a property that is used to produce income – in other words, an investment property – be eligible for the main residence exemption (where any profits derived from the sale are capital gains tax-free)? The quick answer is: provided the property is rented out for less than six years before it’s sold and the owner doesn’t have another principal place of residence, then the main residence exemption still applies. This means that a homeowner could potentially live in their home for two years, rent it out for five years (reducing their mortgage in the meantime) and then sell it, without forfeiting their main residence exemption. In fact, a homeowner could live in their home for two years, rent it out for five years, return to live in it again for one year and then rent it out for a further five and a half years, before selling it. Provided the homeowner hasn’t rented the property for more than six years in a row, they can maintain their main residence exemption for that property. For those who have rented their residence for more than six years, not all is lost, says Les Szekely, director at Horwath. He states that provided the property was rented out after 20 August 1996, and the owners haven’t treated any other property as their main residence during this period, they are still eligible for a partial main residence exemption. Basically, the way it works is that you are only required to pay tax on any capital gains made during the rental period, and not the entire period of ownership. But the generous part about this strategy, says Szekely, is how capital gains or losses are calculated; it’s the difference between a property’s final sale price and its valuation on the date it was first rented out. Therefore, before you rent out your property, get it valued by a qualified valuer first so that this becomes the cost base from which any future capital gains are calculated (for a detailed calculation refer to the example). Let’s say, for instance, that you purchased your property for $300,000 in 1998, and, prior to renting it in 2003, had it valued for $600,000. Come 2008, and you decide to sell your property, securing a sale price of $550,000. In this scenario, you will pay no capital gains tax – even though you rented your property for five years and made an overall capital gain of $250,000. What’s more, you’ll even have a tax loss of $50,000, which can be used to offset current and future capital gains. Example: rent long term and partially claim main residence exemption Simon purchased a small apartment in Paddington for $300,000 in 1997. However, in 1999, Simon was transferred with his work to Jakarta and organised with an agent to rent his apartment while he was away. At the time the apartment was valued at $800,000. Seven years later (one year longer than the 6-year period required to claim a full capital gains tax exemption), Simon returned from Jakarta and sold his apartment during the property boom for $1.1 million. His tax bill is calculated as follows: Calculation of Simon’s capital gain (or loss): Amount received on apartment when sold: $1,100,000 Less: market value of his apartment in 1999: $800,000 Capital gain: $300,000 Simon has to pay capital gains tax of: $300,000(gain) X 365(days over six years)/2,555(total days) = $42,857 However, Simon is also entitled to the 50 per cent capital gains discount since he has held the property for more than 12 months. This means that he will pay tax at his marginal tax rate on a capital gain of $21,428. Depending on his marginal tax rate, Simon shouldn’t pay more than $9,964 in tax on the property.