If you’re going to invest in properties, you have to understand the ins and outs of capital gains. Familiarity with this complex tax system can help you weigh up whether to sell your properties now or later. Grant Thornton’s Tax Partner John Ross explains.
Capital Gains Tax (‘CGT’) was introduced in order 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?
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 in its own right. 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 maybe 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 prima facie, a CGT asset subject to CGT. This includes:
- Houses, apartments, weekenders, shops, offices, factories;
- Options and units in unit trusts;
- Restrictive covenants;
- Rights under an ‘employment contract’; or
- Granting of an easement.
However, certain assets are exempt from CGT:
- Main residence;
- Collectables which cost less than $500 eg jewellery;
- Personal use assets which cost less than $10,000 eg a boat;
- Compensation for personal injury;
- Shares in a Pooled Development Fund;
- Plant and equipment (the gain or loss is assessed as a revenue gain or deduction); or
- Trading stock (including land entered into a development).
The acquisition of each CGT asset is recorded and dealt with separately. The date of acquisition and the cost base may vary for each CGT asset.
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.
When are you liable for CGT?
You make a capital gain 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.
Only when a CGT event occurs can a capital gain or loss 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.
The timing of other CGT events is provided in the CGT legislation.
Subject to the acquisition date of the investment and the date of any improvements made, the cost base of the investment may be reduced by any amounts that have been deducted in relation to the Special Building Write-off of 2.5%.
When does the 50% discount apply?
The CGT discount of 50% for individuals and trusts or 33 1/3% for superannuation entities is only available where the CGT asset has been held for at least one year.
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.
If you acquired the property before 22 September 1999, you may choose to include in your income either of the following items:
- the discounted gain; or
- the difference between the consideration on disposal and the cost base which is indexed for inflation up until 30 September 1999.
For disposals today, the discount method will usually, but not always, result in a better outcome.