Capital gains tax is often used to spook would-be investors out of a market they don't fully understand. It's certainly a key consideration in any property investment approach, but with a careful and strategic plan, there are many ways to reduce how much you'll owe to the taxman on the other side of an investment sale. Like many other taxes within the Australian system, understanding how it's calculated can reveal immediate opportunities to save.
For those who are familiarising themselves with capital gains tax, let's start at the very beginning: what is it?
Capital gains tax, often referred to as CGT, is a tax paid on the capital gain made from the asset's sale. Basically, a capital gain is the difference between what you paid to purchase the asset and what you then sold the asset for. A capital loss is the opposite. Any fees incurred during the purchase are deducted from a capital gain to identify the amount that will be taxed.
Capital gains tax can be nuanced thanks to different kinds of deductions and rules. It's best to speak with a professional in order to build a true understanding of how much you could stand to owe on the sale of an investment property. Before you do so, here are some foundational tips on understanding your potential CGT bill.
When is capital gains tax owed?
Capital gains tax is owed when a property is sold for a gain, which isn't the seller's principal residence. Another exception extends to properties purchased before September 20, 1985. This is one of those areas of nuance, as any major renovations made after this date may then be viewed as a separate asset. They're therefore subject to CGT.
How is capital gains tax calculated?
Gross capital gain can be calculated by deducting the purchase price and associated cost from the sale price. This becomes your capital gains amount. Again, there are exceptions to this base calculation. When a property has been owned by the seller for over 12 months, a 50% discount is applied to the amount of CGT owing. This does not extend to either companies or foreign residents who purchased property after May 8 2012. Those who are using self-managed super funds to invest in property are also only able to receive a discount of one third.
How is capital gains tax counted as income?
This is where understanding the amount of capital gains tax you may owe is a little trickier. Ultimately, capital gains tax is calculated at the same rate as your income tax. It becomes a part of your annual earnings in order to calculate your overall amount of tax owed. Your marginal tax rate affects how much CGT you'll end up paying once the gain on the property (minus expenses, deductions and purchase price) is added to your annual income.
How can you minimise or avoid capital gains tax?
It's well worth investigating the concessions and exemptions that apply to capital gains tax. Qualified professionals can advise on strategic approaches that reduce the overall amount you'll owe come tax time.
These strategies commonly include
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Applying the main residence exemption. Since main residence gains are not subject to CGT, capital gains tax isn't a concern for those who are selling their main residence. This can become more complex if that residence was the owner's home for part of the duration of ownership and used to generate an income (such as rent) for another part of it. In these instances, a proportionate amount of the capital gains will be subject to CGT.
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The temporary absence rule. This exception relates to the main residence exception. If you've moved out of the property, rent it out, and then return to that property within six years, the period for CGT is reset. The property can then be treated as your main residence for an additional six years.
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Investing in superannuation. Although self-managed super funds only receive a one-third discount for applicable CGT, these super funds are only taxed at a standard rate of 15%. By applying the one-third discount, the maximum CGT rate can be reduced to 10%, which is much lower than the average individual marginal tax rate.
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Intentionally timing the capital gain or loss. If you know ahead of time that your income will be lower in one financial year than another, choosing to sell your property during the lower year is one way to reduce the amount of CGT owing. This is thanks to the lower marginal tax rate associated with your reduced income. This also applies to considering the timing of a loss since one loss can be used to offset another gain. Those who are playing in the stock market, selling underperforming shares that have resulted in a loss can then see that loss deducted from their capital gain.
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Maximising partial exemptions. By keeping a property for over 12 months, you'll receive a 50% discount in CGT. Partial exemptions also apply if you move into a rental property. As well, investments in affordable housing attract a 60% reduction in the amount of CGT owing. This is beneficial for prudent investors to keep in mind as they evaluate market opportunities.
CGT and inherited properties
Thankfully, capital gains tax doesn't apply to inherited properties. It may be triggered if that property is sold by the owner who inherited it as it's not the main residence of that seller.
Planning for CGT
As with many parts of the property market, working with a professional is one easy way to save yourself thousands on CGT. The hundreds you spend may result in a significant decrease in your tax bill. Speak with your accountant to understand how your CGT tax can be minimised while maximising your investment return.