Most investors have heard of Capital Gains Tax (CGT) but few understand what it is and how to minimise the amount of tax paid. We take a look at what CGT is and what you can do to decrease the burden it places on your tax returns.
What is Capital Gains Tax?
A capital gain is the profit you make from the sale of an asset or investment that needs to be declared on your tax return as income. CGT is basically the tax you pay on this profit, however, unlike other taxes, it is not applied as a separate rate and is added straight on top of your other income. You’re then taxed at the applicable marginal tax rate. Most people associate CGT with investment properties but it can also apply when you sell shares or a business, even sometimes jewellery and artwork. Unfortunately, there’s no definitive list of items that incur CGT but the Australian Taxation Office gives a pretty good indication on the website of what could potentially be subject to CGT.
How is it calculated?
This is where it gets complicated. First, you need to figure out your cost base. For example, for an investment property this is the amount you originally paid plus incidental costs (legal and agent fees, stamp duty, etc) plus improvement costs (items replaced or improvements made while owning the property) plus ownership costs (land tax, maintenance costs, interest charges and rates). You then subtract the total cost base from the price you sold your asset for to calculate the capital gain or loss. Once you have this figure, you need to work out what tax is payable. For instance, if you owned an investment property for less than 12 months, the entire gain is added to your taxable income whereas holding it for more than 12 months reduces that by half. If the asset is held in a super fund for longer than 12 months, you are eligible for a 33.3% discount.
There are also a number of exemptions. For instance, if the property is your main place of residence or if it was purchased before 20 September 1985, you don’t have to pay CGT. If you use your SMSF to purchase a property, you can also use the fund to take out a home loan which is then paid off through your super contributions. You’ll receive a full CGT exemption if you sell the property after you retire. You may also receive exemption if you sell your investment property within 6 years of moving out if it previously was your principal place of residence.
It’s an unfortunate fact of life that not all investments are successful and not all assets are sold for a profit. In the case of a capital loss, this can be carried forward to reduce any future capital gains and so reduce the amount of tax paid in the future.
As you can see, Capital Gains Tax is quite a complex area of tax law and the above points are only the tip of the iceberg. It’s vital you receive advice from your accountant or tax advisor before acting on any of the information in this article. Keeping your records in order is also important to ensure you can claim everything you’re legally entitled to.