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15-Oct-2020 By - team

Can I avoid CGT?

 

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.

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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.

Capital gains tax

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.

  • Most personal assets are exempt from CGT, including your home, car and personal use assets such as furniture.
  • CGT also doesn’t apply to depreciate assets used solely for taxable purposes, such as business equipment or fittings in a rental property.

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.

 

How much is Capital Gains Tax in Australia?

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.Melbourne Wealth Money

How do I avoid capital gains tax on property in Australia ?

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:

  • You and your family live in it
  • Your personal belongings are in it
  • It’s your address on the electoral roll
  • Your mail is sent to the address
  • Services such as phone, gas and power are connected

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:

  • You and your family live in it.
  • Your personal belongings are in it.
  • It is the address your mail is delivered to.
  • It is your address on the electoral roll, and
  • Services such as phone, gas, and power are connected.

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:

  1. Hold on to any investment property for more than 12 months, and you could receive a 50% discount on your capital gain.

 

  1. Keep detailed records of all your spending on the property from the day you purchase it, to potentially offset the gain down the track.

 

  1. If you are selling an investment property, make the most of a low-income year. As capital gains tax is considered part of your income, a year in which your earnings are expected to be lower than usual could mean you pay capital gains tax at a lower rate.

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:

  • The house is your principal residence
  • It has been the home of you and any dependents you have for the whole period you’ve owned it
  • It has not been used to produce ‘assessable income’ – meaning you haven’t run a business out of it or renting it out, and you aren’t ‘flipping it’.
  • It’s on two hectares of land or less.

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.

Capital gains tax property exemption tool

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):

  • your home, even if you lived in and then left it vacant for a while or used part of it to produce income
  • a rental property
  • an empty block of land.

What this tool doesn’t cover

This tool won’t cover your situation if:

  • the property is on more than two hectares of land
  • you owned two or more properties that had both been your primary residence and the periods you held them overlapped
  • you and your spouse, or you and your dependent children, had different principal residences at the same time
  • the property is being transferred to or from you because of a marriage or relationship breakdown
  • you inherited the property on or after September 20 1985, and there was a dwelling on it when you sold it
  • you were absent from the property more than once, and you used it to produce income (such as renting it out), and either
    • one of these absences is more than six years, or
    • during your absence, the property was completely vacant (you didn’t reoccupy it)
  • you used a part of the property, other than the dwelling, to produce income
  • you had a building or different structure constructed on the property and
    • you acquired the property before September 20 1985, and the building works were after that date, or
    • you sold the property less than three months after you first occupied it
  • you acquired one property (or properties) pre-CGT, and another property (or properties) post CGT, and you amalgamated the titles
  • your property is being compulsorily acquired.

 

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.

If I can’t avoid capital gains tax, can I reduce the amount I need to pay?

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.

Maximum exemption

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:

  • you were absent from the dwelling after occupying it as your primary residence
  • you built or renovated a home on the property and then occupied it as your primary residence.

 

 

DISCLAIMER
THIS WEBSITE CONTAINS GENERAL ADVICE ONLY AND IS NOT PERSONAL FINANCIAL OR INVESTMENT ADVICE. ALSO, CHANGES IN LEGISLATION MAY OCCUR FREQUENTLY. WE RECOMMEND THAT OUR FORMAL ADVICE BE OBTAINED BEFORE ACTING ON THE BASIS OF THIS INFORMATION. INFORMATION CONTAINED HEREIN HAS BEEN SECURED FROM SOURCES EWM ACCOUNTANTS & BUSINESS ADVISORS BELIEVES ARE RELIABLE, BUT MAKE NO REPRESENTATIONS OR WARRANTIES AS TO THE ACCURACY OF SUCH INFORMATION AND ACCEPT NO LIABILITY. WE SUGGEST THAT YOU CONSULT WITH A TAX ADVISOR, CPA, FINANCIAL ADVISOR, ATTORNEY, ACCOUNTANT, AND ANY OTHER PROFESSIONAL THAT CAN HELP YOU TO UNDERSTAND AND ASSESS THE RISKS ASSOCIATED WITH ANY INVESTMENT.

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