Investing in properties is a big decision, involving thorough planning and research on legal documents and taxes. Capital gains tax, one of the many factors to consider when investing in properties, is a subject that many buyers find complicated to grasp.
YourMortgage.com.au spoke to Chan & Naylor Co-founder and non-executive Chairman Ed Chan and discussed all you need to know about capital gains tax.
Capital gains tax is calculated based on investment assets whose values increased, then the asset is sold, and a capital gain is made. A 50% discount on the capital gain for calculating tax purposes is allowed for Australian residents, as long as you have owned the property for 12 months or more.
For example, if you’ve held a property for more than 12 months, making a capital gain of $500,000, you don’t have to pay capital gains tax on that amount. Instead, you pay capital gains tax on half of that which is $250,000.
“There is a risk that is associated with property investment, so the government in their wisdom, (to) attract people to become landlords and to incentivise people to come (and invest), they offered a 50% discount on capital gains,” said Chan.
However, different rates apply to Aussies and foreigners.
Citizens pay capital gains tax based on their personal tax rate, which is not a fixed amount. For example, your personal tax rate is 20%, you will pay 20% on your capital gains. This tax will apply to the amount after the 50% cut.
For instance: let’s say you buy a property for $300,000 and sell it for $430,000, then after all expenses make a capital gain of $100,000. You then apply the 50% discount, reducing your gain to $50,000.
You earn an annual income of $45,000. For the financial year in which your property is sold, your $50,000 gain will be added to your taxable income, raising it to $95,000. You will then pay the equivalent income tax for an income of $95,000.
On the other hand, non-residents do not benefit from the 50% discount.
Chan also said that capital gains tax can be very difficult to avoid for property investors. The only way to minimise it is to hold the property under a taxpayer’s name that has a lower tax rate. The problem is, when buying a property, it could be negatively geared – which is better held by the person earning a higher tax rate.
When negatively geared, a property is better named under the person with a higher tax rate to get a higher ongoing refund.
“It’s generally much better to put the property in the name of the higher tax payer and wear the consequences of the higher capital gains tax later on balance, as you’ll be ahead,” he said.
Capital gains tax also has a six-year rule. Under the rule, a property that was formerly your own home may be excluded from capital gains tax, if sold with six-year of it being rented out. The exemption only applies where no other property is declared as the primary residence.