Capital Gains Tax or CGT is one of those taxes no one really wants to pay.
In fact questions around Capital Gains Tax are very common here on Property Update.
So, let’s dive deeper into CGT so everyone has a better understanding of what it is and how you can minimise its impact on your wealth creation efforts.
So in this blog I will outline the history of CGT as well as how it is applied when you sell an investment property.
What is Capital Gains Tax?
If you ask me, CGT is the last throw of the dice the tax department has to reduce your family’s wealth.
That’s because the more capital gains you have made, due to either a good investment or through a long-term holding, the more tax that will be applied.
Annoyingly, even after your death, your beneficiaries will be taxed on investments you have made that they subsequently sell.
You see, the Australian Taxation Office is very patient and will wait many years or even decades for its last throw of the dice!
In fact, this tax may even be applied in certain circumstances without an asset sale, such as leaving your children an inheritance on your death either as a superannuation payment (not exactly CGT but a tax nevertheless) or if they are living overseas at the time of your death depending on the assets.
When it comes to calculating how much CGT you have to pay, other than in superannuation, there is no specific rate of tax that is applied, rather, the tax rate will depend on your personal marginal tax rate.
By understanding more about CGT, including how to calculate it and minimise it, investors are better placed to make educated decisions about their tax liabilities as well as the best times to sell assets.
Now for a bit of a history lesson:
Capital Gains Tax was introduced in Australia on 19th September 1985 and applies to any asset acquired after that time caught under the legislation.
The legislation itself describes a capital gain or capital loss on an asset as the difference between what it cost you and what you receive when you dispose of it.
These sums are inclusive of most costs applying to the purchase and sale – not just the amount specifically paid or received for the asset.
As I mentioned, there is no specific “tax rate” for CGT and it is not even a separate tax.
Instead, the applicable gains are added to a taxpayer’s income and the tax rate is applied to their total income, which includes the capital gain or loss.
Under legislation in March 2019, if the asset was purchased as an investment (as opposed to an intention to sell) and is held for more than 12 months then any capital gain (increase in value) is first reduced by the general 50 per cent discount for individual taxpayers or by 33.3 per cent for superannuation funds.
If a company makes a capital gain, then no discount is applicable.
For tax payers, capital losses can be offset against capital gains before the discount and net capital losses in a tax year may be carried forward indefinitely.
Capital gains for a tax payer can be netted of any normal income losses in the same tax period but capital losses cannot be offset against normal income.
So what do you pay CGT on?
Under normal circumstances personal assets are exempt from CGT.
These include things like your home, your car, and most personal use assets such as furniture.
CGT also doesn’t apply to depreciating assets used solely for taxable purposes, such as business equipment or fittings in a rental property.
However, under certain circumstances there may even be a CGT consequence on the sale of the family home, but this is the exception and I’ll discuss this in a future article in this series.
Australian tax residents are taxed on their worldwide income so that means that CGT applies to your assets anywhere in the world.
Income tax is also applied to any normal income generated or received from non-Australian assets and a tax benefit may apply if the income or capital gains are generated in a country with a double taxation agreement such as with New Zealand.
On the other hand, non-Australian tax residents who make a capital gain or capital loss on an asset that is “taxable Australian property” will pay the appropriate tax in Australia without the benefit of the general 50 per cent discount.
When does CGT apply?
Just to clarify things, when you sell or otherwise dispose of an asset it’s called a CGT event.
Of course it’s important to establish the timing of a CGT event because it tells you in which income year to report your capital gain or capital loss.
And the result may affect how you calculate your tax liability.
In short…the date of the CGT event is the contract date for the disposal and not the date the sale is finalised, which is commonly referred to as the settlement date.
In my next article in this series, I will outline the two principal methods used to calculate CGT.
Note: This is a general summary only – you can get more information from the ATO here or form a registered tax professional
Ken Raiss is director of Metropole Wealth Advisory and gives independent expert advice for property investors, professionals and business owners. He is passionate about real estate investing and small business and is a regular commentator for Michael Yardney's Property Update.
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Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.