The capital gains tax is something most Australians have heard of, at least in passing. However, like many financial concepts, it tends to be surrounded by a great deal of confusion and misconception.
If you intend to purchase (or have already purchased) and sell a property, you will inevitably have to deal with the capital gains tax on some level. By familiarising yourself with the capital gains tax ahead of time, you can save yourself time, stress and money when the time comes to sell.
Read on for our ultimate guide to the CGT, including how to calculate capital gains tax, how to avoid or minimise the amount you pay and more.
This is the time when the Federal Government gets its share of the profit that you’ve made from investing in property as it’s technically classed as personal income.
So, in this article we’ll outline what CGT is, how to minimise it, and how to calculate it, so no one’s surprised when the taxman (or woman) comes a-calling.
You own an investment property. Since you bought it, the value has just gone up and up—the thought of unlocking that equity has you dreaming of far-flung destinations and shiny new toys. But before you crack open that nest egg, make sure you do your research.
Knowing the implications of, and how to avoid, capital gains tax when selling an investment property could save you a small fortune. In this post, you’ll learn what it is, when it applies and tips to reduce the taxes on selling a house.
Capital gains tax usually rears its head whenever you sell an asset for a profit, but selling your home may be a different story.
You may have encountered the term’ capital gains tax’ (CGT) if you’ve ever looked into the possible implications of selling an asset, such as a property. According to the Australian Taxation Office (ATO), how it usually works is that any capital gain (profit) you make as a result of selling a capital asset is added to your assessable income for the year and taxed at your marginal rate. That being said, there are a handful of exceptions that can apply when it comes to selling a house, depending on factors such as what the house was used for and when you bought it.
We’ve looked at some of the considerations below, but it may be beneficial to seek the advice of a qualified tax agent if you need help with your tax arrangements.
If you sell a capital asset, such as real estate or shares, you usually make a capital gain or a capital loss. This is the difference between what it cost you to acquire the asset and what you receive when you dispose of it.
You need to report capital gains and losses in your income tax return and pay tax on your capital gains. Although it’s referred to as capital gains tax (CGT), this is actually part of your income tax, not a separate tax.
When you make a capital gain, it is added to your assessable income and may significantly increase the tax you need to pay. As tax is not withheld for capital gains, you may want to work out how much tax you will owe and set aside sufficient funds to cover the appropriate amount.
If you make a capital loss, you can’t claim it against your other income, but you can use it to reduce a capital gain.
All assets you’ve acquired since tax on capital gains started (on September 20 1985) are subject to CGT unless specifically excluded.
The point at which you make a capital gain or loss is usually when you enter into the contract for disposal, not when you settle. So if you sign an agreement to sell an investment property in June 2017, and determine in August 2017, you need to report the capital gain or loss in your 2016–17 tax return.
If you’re an Australian resident, CGT applies to your assets anywhere in the world. For Norfolk Island residents, CGT applies to assets acquired from October 23 2015. Foreign residents make a capital gain or loss if a CGT event happens to an investment that is ‘Australian taxable property’.
According to the ATO, capital gains tax (CGT) is not a separate tax, but rather what’s added to your income tax as the result of a capital gain. This means that CGT is charged at whatever your marginal tax rate is. Keep in mind that a capital gain may potentially increase your assessable income by enough to push you into a different tax bracket.
The ATO warns that tax is not withheld on capital gains in the way that it is on other payments such as a salary you receive from an employer, so it may be prudent to set funds aside for tax time if you think you may need to pay CGT. If you make a separate capital loss in the same financial year, the ATO clarifies that this won’t reduce your taxable income, but you can potentially use it to offset or minimise how much CGT you owe.
The vast majority of people pay Capital Gains Tax on a rental property when they sell, or dispose, of it, so it’s essential to understand how CGT is calculated.
CGT can be a little tricky to calculate, that’s why it’s so important to have specialists on your side – and especially a good taxation accountant.
Remember CGT is only payable in the financial year in which you sell or dispose of your rental property. So, if you follow a long-term wealth creation strategy, you won’t need to worry about paying this for many years or possibly decades. In the meantime, you can access any capital growth to grow your portfolio and improve your overall financial position.
For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset – that is, where you receive more for an investment than it cost you. According to the ATO, the cost base of a CGT asset is mostly what you paid for it, together with some other costs associated with acquiring, holding and disposing of it.
If the rental property or asset was acquired before 1985, then no CGT is payable; however, significant improvements to a property since that time may be subject to CGT.
There are a few strategies you can use to eliminate or minimise the capital gains tax you pay on a property.
If you live in your property for at least six months once you purchase it, you may be exempt from the capital gains tax. However, in this situation, you must be able to prove it’s your primary place of residence. The criteria used to determine whether a property is your primary residence include:
There is also a tax break known as the six-year rule. This states that if you purchased the property to live in and had to move for reasons like a job or extended holiday, you can also become exempt from the CGT while leasing it out.
However, this exemption can only be claimed if no other property is nominated as your primary residence. Interestingly, if you eventually move into the same stuff, the six-year exemption resets.
Under the principal residence exemption, you’re generally not required to pay capital gains tax if you sell the home you live in. When it comes to property, one of the significant exemptions from Capital Gain Tax is if it’s your home or principal place of residence (PPOR). You can generally claim the principal residence exemption from CGT for your home.
To get the exemption, the property must have a dwelling on it, and you must have lived in it.
You’re not entitled to the exemption for a vacant block.
Generally, a dwelling is considered to be your principal residence if:
There is also a tax break which you may be able to access if your PPOR becomes a rental property. There is a special six-year rule, which means that a property that was previously your PPOR can continue to be exempt from CGT if sold within six years of first being rented out.
The exemption is only available where no other property is nominated as your primary residence.
What’s interesting about this rule is that if the same dwelling is reoccupied as your principal residence, then the six-year exemption resets.
So another six years of exemption is available from the date it next becomes income-producing.
To get the best possible advice on how to avoid capital gains tax in Australia, you should talk to a tax accountant. They’ll consider all the options and help you prevent or reduce the amount you are liable to pay, including whether you are eligible to claim that the property you are selling is actually your primary residence.
But there are some things you can do to minimise your capital gains tax. To keep it simple, follow these three-pointers:
According to the ATO, you will generally not be required to pay any capital gains tax when you sell your house, so long as all of the following criteria apply:
You will also be exempt from paying CGT on the sale of your house if you bought it before September 20, 1985, when CGT was introduced. Note that these criteria also apply to capital losses which, if exempted, cannot be used to offset your assessable income, the ATO explains.
The rules around paying CGT on a property inherited from a deceased estate are slightly more complicated, as they require knowledge of when the dead acquired the property as well as how much it was worth at the time, the ATO explains. In these situations, in particular, it could be worth getting tax advice from a qualified expert.
Recent changes to the law mean that foreign residents can no longer claim the principal residence CGT exemption when they sell property in Australia, except in certain circumstances.
Foreign residents who already held property on May 9, 2017, can claim the principal residence CGT exemption until June 30 2020. For properties acquired after May 9 2017, the CGT principal residence exemption no longer applies to disposal of stuff from that date, except in certain circumstances.
If you’re affected by this change, see Capital gains tax changes for foreign investors. Administrative treatment explains what you need to do. If you’ve sold a property or plan to sell one (or otherwise dispose of one), you can use this tool to work out what percentage of your capital gain is exempt from capital gains tax (CGT).
You need to have owned the property as an individual, either in your own right or jointly with someone else. The tool covers situations where the property is (or was):
This tool won’t cover your situation if:
If your situation is listed above, see Capital gains tax – Your home and another real estate to find out how CGT applies to your circumstances.
Even if your house doesn’t meet the criteria for a full exemption (such as if it’s an investment property), the ATO advises that you may be able to reduce how much tax you have to pay on your capital gain.
For example, suppose you owned the property for at least 12 months before selling it. In that case, you will generally be eligible for a 50% discount on any applicable capital gains tax, if you are an Australian resident. If you’re a foreign resident, you will generally not be eligible for this discount, the ATO says.
It’s also worth noting that, according to the ATO, you can carry forward a net capital loss from a previous year to offset a net capital gain in a different year – the loss can be carried forward indefinitely until used in this manner.
The tool is designed to give you the maximum exemption for capital gains. It automatically increases your exemption percentage to cover some or all of those periods when you didn’t occupy the property, provided you met certain conditions. You’ll be disadvantaged by the exemption percentage being increased automatically if you made a capital loss and either:
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