If you’re going to invest in properties, you have to understand the ins and outs of capital gains and how they are taxed.
Capital Gains Tax (CGT) was introduced to level the playing field between various taxpayers. Prior to the introduction of CGT, profits made on the sale of capital assets were tax-free. This led to a distortion in investment decision-making as investors sought to invest in assets that could be sold free of tax. The introduction of CGT was accompanied by a wholesale reduction in marginal tax rates.
- What is CGT?
- What properties are subject to CGT?
- What are considered CGT events?
- When are you liable for CGT?
- When does the 50% discount apply?
What is CGT?
CGT is the tax charged on any capital gains that arise from the sale or disposal of any asset bought or acquired after September 1985. It is not a separate tax from your income tax — rather a “net capital gain” is included in your taxable income and taxed at your marginal tax rate. The “net capital gain” is reduced by your capital losses for the income year and unapplied capital losses from previous income years.
To calculate your net capital gain subject to tax:
- Take your total capital gains for the year
- Deduct total capital losses (including any net capital losses from the previous years)
- Deduct any CGT discounts or concessions you may be entitled to
- The total you get is your net capital gain subject to tax
If you carry on a small business, the small business concession may be available to further reduce your capital gain.
What properties are subject to CGT?
Any kind of property is an asset subject to CGT. This includes houses, apartments, weekenders, shops, offices, factories.
However, certain assets are exempt from CGT, including your main residence, cars, personal-use assets which cost less than $10,000, and others.
You can apply for CGT relief if you are a small businesses-owner. You may be entitled for concessions if you are going through marriage breakdown and restructuring situations. Working from home can also reduce the main residence exemption.
What are CGT events?
In simplest terms, CGT events refer to transactions or instances where a capital gain or loss can be realised. Such events include when:
- You sell or give away an asset to someone else;
- An asset you own is lost or destroyed;
- Shares you own are cancelled, surrendered or redeemed;
- You stop being an Australian resident; or
- A company makes a payment to you that is not a dividend.
The time an acquisition occurs is important because if it is determined that an asset was acquired before 19 September 1985, no CGT will arise. When a disposal occurs, the capital gain is determined at the date the contract is entered into, rather than upon completion.
Also read: How much does it cost to sell your home
When are you liable for CGT?
In technical terms, you will be liable for CGT if you make a capital gain — that is if the amount you receive from a CGT event exceeds the cost base of that CGT asset disposed, for example if you receive more for the CGT asset than what you paid for it.
The cost base of an asset consists of 5 elements:
- Money (or market value of property given) to acquire it.
- Incidental costs to acquire it, including surveyor valuer, broker, accountant or legal adviser, stamp duty, real estate agent costs.
- Non-capital costs of ownership (if acquired after August 1991) including interest, insurance, rates or lands tax (if the asset is land).
- Capital expenditure incurred for the purpose of increasing the assets value.
- Costs in defending your title to property.
The ATO now allow costs incurred in engaging a ‘stylist’ to market a property, together with related furniture hire costs, as part of a property’s cost base.
Initial repairs should be capitalised. Repairs that are more than a replacement or renewal of worn-out parts should be added to the cost base and claimed as a deduction when the asset is disposed of. You need to keep records of each element for five years after a CGT event has happened.
If you have or can deduct expenditure, it does not form part of the cost base. That is, costs, which can be deducted, such as interest and rates for an income-producing property, cannot be included in the cost base.
When does the 50% discount apply?
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. Indexation or not
Under the original CGT rules, the cost base of an asset was indexed for inflation if the asset had been held for at least 12 months. Effectively only “real” gains were being taxed. However, the introduction of the CGT discount in September 1999 saw the removal of indexation for assets acquired after this date, while all pre-existing assets had their indexation frozen at this date.
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.
Your Mortgage Capital Gains Tax Calculator can help give you an estimate of the CGT you may have to pay when you sell your investment property.