While the sale of your family home – or main residence – is usually tax free, each time you sell an investment property you must pay Capital Gains Tax (CGT) on the transaction.
Therefore it’s important to understand how this tax rate is calculated, so you can manage your investment to minimise the amount of CGT you will need to pay.
What is CGT?
CGT is a tax charged on any capital gain – or profit – that you realise on the sale of a capital asset, like property or shares.
You need to include your ‘net capital gain’ on your tax return. This amount is treated as assessable income, and the normal marginal tax rates will apply to your income for that financial year.
With an investment property, the CGT applies on the date you sign the contract of sale. You must declare the profit or loss from the sale on your tax return in the same year as the sale took place.
How is CGT calculated in Australia?
The calculation for CGT takes several factors into account. These include the capital proceeds – which is the money gained through the sale – and a cost base for the investment.
The cost base includes a number of outgoings. These include the original purchase price of the property and a number of extra costs associated with maintaining the asset.
Therefore CGT applies to the net capital gain – the assessable income after the cost of acquiring and holding the asset has been factored in, and any CGT discounts have been applied.
How do I minimise CGT?
- Hold your investment property for at least one year
If the investor has owned the property for over one year they can apply a 50% CGT discount to their gross capital gain figure, to calculate their net capital gains for their tax return. This means they will only pay CGT on half of the gross capital gain figure.
An investor sells a home for $500,000, creating a capital proceeds figure of $500,000.
The investor originally paid $250,000 for the property. Furthermore, they incurred several fees, including stamp duty and other costs amounting to $25,000. Finally, the investor claimed $50,000 in building depreciation and capital improvement costs. This creates a total cost base of $325,000.
Subtract $325,000 from $500,000 and you calculate how much gross capital gain results from the sale. In this case, it’s $175,000. The investor adds this figure to his or her annual income on the tax return for the year of sale. This income is subject to tax in the same way as the investor’s other income. Thus, this creates the CGT.
However, if the investor owned the property for over a year he or she could apply the 50% CGT discount and would only need to add $87,500 to the income declared on the tax return.
- Keep records of your expenses
It’s important to keep detailed records of all the expenses incurred in holding the property so you can use them to offset your tax liability. These could include:
- Stamp duty on the asset
- Fees for professional advice on its purchase and sale
- Insurance premiums
As mentioned in the previous scenario, you may also be able to add the cost of building depreciation to your expenses. Keeping thorough records means that you won’t pay more tax than you need to.
- Sell in a low-income financial year
It makes sense, if possible, to time the sale of your asset to a low-income financial year. This is because you will pay less CGT on a lower income threshold.
If, for example, you have had time out of the workforce in a given year and your employment income is minimal, it could be an opportune time to sell and minimise the CGT payable on your investment.
When does a capital loss happen?
A capital loss occurs when the cost base figure is larger than the capital proceeds figure. Investors may use a capital loss to offset income for the year.
Unfortunately, a capital loss can only offset capital gains. You gain no benefit from a capital loss unless you also have capital gains.
Let’s take our $175,000 example from above. If the same investor sold another property for a capital loss of $20,000, they could subtract this from the $175,000. This would create $155,000 of taxable income.
However, the investor can’t use that $20,000 to offset any other form of income.
Trusts and Companies
The rules detailed above apply to individual investors. The CGT is different for companies and trusts.
Investors who purchased their properties before 1990 also face a different situation. They must use a different calculation for the cost base. The same applies for non-residential investment properties.
Find out more
Talk to an expert accountant for specific advice related to your own situation. They can help with financial planning and tax advice.
With Alexi Neocleous
The information in this article is general in nature. Please seek advice from a licensed professional when making financial decisions.