Capital Gains Tax 101
It’s easy to get swept up in the rush of investment buying and forget about the tax implications of your strategies and purchases. After all, who has time to think about the after-tax when choosing the right home, for the right strategy, in the right area, is already hard enough? However, being aware of the tax implications may just be the difference of a poor investment and one that is performing to its maximum potential. Tax policies like the Capital Gains tax in Australia are important to note especially if you plan on selling your investment within the next financial year. Here’s our capital gains tax low down:
Capital gain is the difference between what you paid for an asset (less any fees incurred during the purchase) and what you sold it for (likewise less any fees incurred during the sale). Capital gains tax (CGT) is, you’ve guessed it, the levy you pay on the capital gain made from the sale of that asset.
For example, If you bought a house for $800,000, then sold it for $1M, you earned $200,000 in capital gain, or less if there were extra costs incurred in transferring or holding the asset.
In Australia, you pay tax on the $200,000 in the year that the property is sold as part of your annual income for that year. If you sold it after owning it for longer than 12 months, the amount is halved, so $100,000 is taxable in the year that you sold it.
But CGT doesn’t just apply to property, it also extends to shares, leases, goodwill, licences, foreign currency, contractual rights, and personal use assets purchased for more than $10,000.
The good news is your car, main residence, depreciating assets used solely for taxable purposes, and assets bought before 20 September 1985 are exempt from the tax. However, if your main residence sits on more than two hectares of land, or you’ve not lived in it for the entire period of ownership, you’ll only be afforded a partial CGT exemption on your home.
Lastly, even if your asset is outside of Australia, as an Australian, CGT will still apply.
So how do we calculate Net Capital Gain/loss?
The formula for calculating a net capital gain or loss is as follows:
Capital gains tax, however, is calculated by taking into consideration your total annual taxable income as well as your capital gains/loss. Most people leave it up for the pros to calculate their tax for them, but if you’re just planning potential purchases using an online calculator can suffice and help give you a rough idea of what direction to head.
Managing your CGT
If, however, before the end of the financial year you have a CGT liability, there are a few strategies that you could consider to reduce the pain.
Use a capital loss to offset your tax: Selling poorly performing assets that no longer suit your circumstances before the end of that financial year is one option. By selling a poorly performing asset (i.e. an asset where the value has decreased) and thus incurring a capital loss, you may be able to offset a realised capital gain from another asset in the same financial year, allowing you to manage your capital gains tax liability. It may also free up money for more suitable investment opportunities.
Stay in it for the long haul: Another way to reduce CGT is to hold onto the investment for more than 12 months. For assets purchased after 21 September 1999, investors have been entitled to claim a 50 per cent discount on capital gains they make on assets held for longer than 12 months from the date of purchase.
Delay any income: If you are thinking of selling off a profitable asset, such as shares or property, it may be worth deferring this sale until after the end of the financial year. In doing so, you will delay incurring CGT for another financial year. So, while you will still need to pay the CGT eventually, freeing up short‑term cash flow may be beneficial, depending on your circumstances.
Reduced exclusion for second home used as primary home: As of January 2009, new tax rules require that, if you sell a home that you sometimes used as a vacation or rental property and sometimes as your primary residence, you’re eligible for only that portion of the capital gains exclusion that corresponds to the amount of time you actually lived there as your primary residence.
Discount method vs indexation method: If you acquired your assets between 20 September 1985 and 21 September 1999, you have the option of using the indexation method to calculate the CGT payable. This method takes into account inflation of the cost base for the asset, meaning you will pay tax only on the capital gain in excess of inflation.
You can usually decide on the option which will ensure the least amount of tax is paid. We recommend that you seek taxation advice on this matter.
Rollover provisions: Rollover provisions allow the deferral of capital gain, either by letting a new owner keep the previous owner’s cost base or by letting an owner switch to a new similar asset and keep the old cost base. These include:
- Death – On death, CGT assets transferred to beneficiaries (either directly or first to an executor) are not treated as disposed of by the deceased, but instead the beneficiaries are taken to have acquired them at the deceased’s date of death and with cost base and reduced cost base as at that date.
- Marriage breakdown – When assets are transferred between spouses under a court-approved settlement following marriage breakdown, certain rollover provisions automatically apply. Essentially the spouse receiving the asset keeps the original cost base and acquisition date. Newly created intangible assets like rights or options have a cost base of only what was actually spent in creating them (solicitor’s fees for instance).
- Takeovers – “Scrip for scrip” rollover may be available for a takeover or merger where a shareholder receives new shares or new trust units rather than cash. When rollover is available the new shareholding is treated as a continuation of the old, with the same cost base and date of acquisition.
- Demergers – When a company spins off part of its business as a new separate company and gives shareholders new shares in that new company, the taxpayer’s cost base of the original shares is split between the original and the new holding. The company advises the appropriate proportions and the shareholder would allocate the original cost base between the two entities. The new holding is taken to be acquired at the date of demerger. The cost base of the original shareholding is reduced by the cost base of the new shareholding.
- Destruction or compulsory acquisition – When an asset is compulsorily acquired by a government agency or is destroyed and insurance or compensation is received, the taxpayer may choose between:
Regarding it as a sale at that price.
Rollover whereby the compensation is used to replace or repair the asset and it is considered a continuation of the original. The original date of acquisition is not changed, in particular, a pre-CGT asset continues to be pre-CGT.
- Small business – Four capital gains tax concessions for small businesses have been available since 21 September 1999.
The bottom line
Although making the right purchasing decisions and investment strategies is a large part of being a successful investor, minimising taxes is a large element of the planning process that most overlook. Although it’s not the end-all be-all, taking reasonable measures will help avoid nasty surprises come tax time.