Property investing can be rewarding; however, it also comes with some of its own share of tax implications. Of all the taxes, one of the most important that property investors in Australia need to know is Capital Gains Tax.
Whether you’re a seasoned investor or just starting your journey into the property market, a good understanding of CGT will serve you well in making better financial decisions. This guide will outline:
- What CGT is
- How it works
- Some basic strategies that you can implement to manage your tax liabilities effectively
What is Capital Gains Tax?
Capital Gains Tax is the tax on the profit that you make when you sell something like your investment property. In Australia, CGT isn’t a tax in itself but is rather part of your income tax.
Any gain or loss made from the sale of the property is part of your income for that particular financial year, and you are taxed on your marginal tax rate.
When Does CGT Apply?
CGT comes into play at the time when you sell your investment property and book some profit. It is important to note that CGT is not related to the mere sale of property. In fact, there are several instances which may give rise to CGT, which include:
- Transfer of ownership
- Gifts on the property
- Termination of lease and/or the granting of a long lease
- Compensation payouts for property damage or destruction
Being in the know of these triggers makes you develop better planning and prevents you from getting surprised by some tax bills at the end.
How to Calculate Capital Gains
The calculation of your capital gain involves the following few steps:
- Determine the Cost Base: This includes the original purchase price of the property plus associated costs like:
- Stamp duty
- Legal fees
- Any capital improvements made
- Calculate the Sale Price: This is the amount you receive when you sell the property, minus any selling expenses like agent fees and advertising.
- Subtract the Cost Base from the Sale Price: The result is your capital gain (or loss if the result is negative).
Example Calculation
If you bought an investment property for $500,000, and over time, you spent $50,000 renovating it and another $20,000 in buying-related costs. Your cost base would then be $570,000
Assume you sell the same property for $800,000 after some time and your selling expenses are $30,000, then your sale price is $770,000.
Capital Gain = Sale Price ($770,000) – Cost Base ($570,000) = $200,000
This $200,000 will be added to your income of that year and will be taxed on it.
CGT Discounts and Exemptions
How can you get around paying any CGT?
50% CGT Discount
If you sell your investment property after holding onto it for more than 12 months, you can receive a discount of 50% on the capital gain. You will be required to add only half of this gain to your taxable income
Main Residence Exemption
One of the most important CGT exemptions is that of your main residence. You might be exempted from paying CGT if the property was your main residence. This is not true for any investment property and applies only when one lived in the property for a certain period
Partial Exemptions
However, if the property has been your main residence for some period but later became an investment property, you may be able to get partial exemption. The exemption depends on how long you lived in the property compared to the period you have owned it.
Temporary Absence Rule
If you move out of your main residence and let it, then you can claim it as your main residence for up to six years, if you don’t own another main residence during that period. You might get an exemption from CGT for that period.
CGT Reduction Strategies
Are there any ways you can reduce the amount of CGT you pay?
Offsetting Capital Losses
If you have other investments which gave rise to a capital loss, you can apply these against your capital gain, reducing your net taxable amount. Alternatively, you can bring capital losses forward to subsequent years.
Using a Trust or Company Structure
Investing through a trust or company is another option for ownership structure that can offer tax advantages such as income splitting and possibly concessions on any CGT.
However, such a structure involves professional advice and requires much careful planning to make sure it complies with the regulations and functions well.
Record Keeping
Keeping good records is necessary for any capital gains tax calculation. You should keep any papers that you received from the purchase, improvement, and sale of any property. Specifically:
- Purchase contracts and settlement statements
- Receipts for:
- Legal fees
- Stamp duty
- Renovations
- Sale contracts and agent fees
Keeping good records means you can substantiate your claims and ensure you maximise your cost base, thereby reducing your capital gain.
Impact of Capital Gains on Overall Tax Liability
Capital gains may have a strong effect on your overall tax liability to the extent that the gain propels you up a tax bracket. You must, therefore, appreciate how CGT interacts with your overall income tax.
For the high-income earner, this additional income contributed by a capital gain may catapult them to pay more than they perhaps had earlier budgeted for. You need, therefore, in this regard, to plan ahead and work out how the sale of the investment property fits into your overall financial plan.
Maximising Superannuation Contributions
One possible strategy to deal with CGT might be to use excess money from the sale to put more into your superannuation fund. By diverting part of the proceeds into superannuation, you are bringing down your taxable income; moreover, you will be in a very advantageous position as far as concessional tax rates on super contributions are concerned.
For those nearing retirement, this turns out to be an extremely viable option because that’s when they can top up their superannuation account.
Role Played by Depreciation
During the period one owns the investment property, depreciation can be one of the keys to minimise your taxable income. Anything from common fixings and fittings to construction costs is depreciable over years.
The catch is that such claims are added to your cost base when you calculate CGT, thus increasing the capital gain, so you must keep track of every single claim relating to deprecation.
But consider that if you have been claiming $20,000 of depreciation over the years; then when you calculate your CGT, the $20,000 would be added to your capital gain. This would, in essence, inflate your CGT – possibly pushing more into the higher brackets and increasing your payable amount to the ATO.
Conclusion
It will be very handy for any investor looking to get involved with investment property in Australia to understand how to deal with Capital Gains Tax. Ignorance about when, how it will apply, its calculations, and how you can minimise amounts applied significantly makes you shortchanged.
Employ professional advice so that the right decisions made at the time of investment reduces tax payable while achieving the goal of having an optimum investment.
Through proper means and adequate preparations, you will have your Capital Gain obligations looked after, taking full control, so that property investment remains a very profitable and rewarding part of your financial strategy.
