Investors in real estate frequently have questions about capital gains tax, a topic of taxation. The law may seem complex, but before selling an asset, all investors need to have a solid understanding of it.
What is Capital Gains Tax
Any asset you have acquired since 1985 is subject to Australia's capital gains tax, unless specifically exempted.
A capital gain or loss on an asset, according to the Australian Tax Office, is the difference between the price you paid for it and the amount you receive when you sell it.
Despite being known as CGT, the tax you pay on capital gains is actually a component of your income tax and is not to be confused with other taxes.
The term "capital gains tax" refers to the tax that must be paid if a profit is generated from the sale of an investment property. This type of benefit is referred to as a "capital gain" in the financial world. It is the difference between the amount that you initially paid for the asset, known as the cost base, and the price at which it was sold, known as the sale price. As part of your taxable income, it is subject to taxation at the highest rate applicable to you (your marginal rate).
It's possible that you'll make a gain or a loss on the sale of a rental property, depending on how you decide to dispose of it. In principle, if you have a nett gain in the value of your capital assets during the course of a tax year, you will be liable to pay capital gains tax (CGT). In the event that you incur a nett loss of capital, you have the option of carrying that loss forwards and deducting it from any future capital profits.
A capital gain or loss is the difference between the amount you paid to buy a piece of property and make modifications to it (the property's cost base) and the price you earn when you sell the property. This difference can be positive or negative. The cost base of the property does not include any amounts that you have previously claimed as a tax deduction or that you are qualified to claim as a tax deduction. The initial purchase price of an asset is often considered to be its cost base for purposes of the capital gains tax (CGT). Additionally, it takes care of some additional costs connected to the process of purchasing, maintaining, and selling the asset.
If you bought the property before the capital gains tax was implemented on September 20, 1985, you will not be required to report any capital gains or losses. It is possible for you to have a capital gain or loss from the renovations made to the property after the 20th of September 1985, even if you bought the property before that date.
When exactly do you have to start paying tax on the appreciation of an investment property?
The transaction that results in a capital gains tax (CGT) event is the sale of an asset. This point in time is extremely important since it determines the income year that the tax will be applied on. Real estate investors experience a capital gains tax event (CGT event) whenever they enter into a contract of sale and so cease to be the owner of the property. The capital gains tax (CGT) is then imposed on you during the same fiscal year that the sale of your property occurred.
It is essential to keep detailed records of this process so that you can accurately evaluate whether you made a profit or a loss on your investment. Investors in real estate are required to preserve these records for a period of five years after the CGT event.
When you have a capital loss, the fact that you can carry forwards the money as part of your unapplied nett capital losses makes this aspect of the situation extremely important. A taxpayer's total reportable income does not go down when they take a loss on an investment. Instead, taxpayers might choose to use the loss as a reduction against a capital gain that they will realise in either the current or subsequent tax year.
Tax on Capital Gains Calculation
A fundamental CGT calculation formula is as follows:
To calculate the gain on an investment, take the difference between the buying price and the selling price, then add any fees associated with the transaction (or loss)
If you bought and sold an investment property in a period of less than one year, the nett gain on the property will be subject to taxation because it was considered a short-term investment. However, if you have owned an investment property for more than a year, calculating your nett capital gain can be done in one of two ways: either through discounting the sale price or indexing it. You have the flexibility to go with whatever alternative reduces your capital gain the most, provided that you meet the requirements.
For instance, if an asset is kept for at least a year, any gain is first reduced by fifty percent for individual taxpayers and thirty-three point three percent for superannuation funds.
Capital gains tax exemptions
There are some conditions that must be met before a CGT exemption can be granted. Exemptions from capital gains tax include the principal residence rule, the six-year rule, the six-month rule, and the 50% discount rule.
Rule of fifty percent: As was said before, in order to be eligible for a CGT deduction of fifty percent, a real estate investor must have owned an investment property for a period of time greater than one year.
When a person resides, occupies, and lives in a property as their home, that location is referred to as their primary place of residence. An owner is qualified for a complete CGT exemption if a property is regarded as their primary residence.
Regulation of six years: According to this rule, a homeowner is eligible for a capital gains tax exemption for a maximum of six years if they rent out their primary residence after moving out of it. If the property owner moves back into the house and then leaves it again within six years, a new six-year period will begin counting down from the time they left the house the last time.
A homeowner is exempt from capital gains taxation if, for a period of six months, they regard more than one of their properties to be their primary residence. The owner of the property must fulfil one of the following requirements in order to qualify:
- At least three months of the previous homeowner's time were spent there over the preceding year before the residence was put up for sale.
- An owner did not use the property in any way that resulted in reportable income at any stage during the preceding year and a half before selling it.
How to Avoid CGT?
The capital gains tax (CGT) that must be paid upon the sale of an investment property is one of the disadvantages of renting out the property as an investment. The tax known as CGT is levied on any capital gains that are made from the sale of an asset. If you have a greater amount of capital gains than capital losses within a given tax year, you will be required to pay this tax.
However, there are legitimate ways to get around having to pay CGT if you rent out your home to others. The Australian Taxation Office (ATO) will grant requests for exemptions from the payment of tax on capital gains under certain circumstances.
The way people spend their lives is constantly evolving. It is possible that you will choose to rent out your primary place of residence for a variety of reasons, including a shift in your goals for the future or a change in the conditions of your life. If you want to avoid paying CGT when you do this, make sure you understand the rules that the ATO has made about this matter.
The following basic guidelines should be followed:
- The capital gains tax exemption (CGT) will only apply to your primary residence. Therefore, it is impossible to avoid paying capital gains tax (CGT) on both residences if you own two homes, live in one of them for a few years, and then go back and forth between your primary residence and the other property.
- If you purchased a home after 7.30 p.m. on August 20, 1996, in order to be eligible for a full exemption, you are required to have lived in the home when it was first purchased (i.e., you cannot have rented it out). The reason for this is that the ATO considers you to have acquired the property solely for the purpose of using it as an investment to generate revenue if you immediately begin renting it out.
- If you rent out your house for a period of less than six years, you are eligible for a capital gains tax exemption provided that the conditions outlined above are satisfied.
- If you have held onto a property for more than a year and the ATO has determined that you are subject to CGT, you are eligible for a discount equal to half of the standard rate.
Since the amount of the capital gains tax owed depends on the specifics of each individual's situation, filing a claim can quickly become extremely difficult. This is especially true in situations in which you own many properties and increase the number of times per year that you relocate from one house to another.
The calculation for the capital gains tax (CGT) is based on the sale price of a property minus any expenses associated with the sale of the investment property. Your cost base is comprised of these many expenditures. The cost base includes the complete sum of the initial purchase price, as well as any incidental charges, ownership and title costs, and depreciable things, less any government grants that were received and any assets that had already been written off. Before 1997, the cost base calculations did not take into account items of the building that were subject to depreciation.
Expenses that aren't directly related to the main transaction, such as stamp duty, legal expenses, agency fees, and advertising and marketing charges.
The costs associated with ownership, including mortgage interest, property taxes, insurance, and utilities. Note that you can only add rates, land tax, insurance, and interest on borrowed money to your cost base if you acquired the property after 20 August 1991 or if you didn't use the property to produce an assessable income, such as vacant land or primary residences. This restriction applies even if you don't use the property to produce an assessable income.
Improvement costs - replacing kitchens, bathrooms or any other improvements you've made on the property
Title costs - legal fees associated with organising and defending your title on the property
It is possible to deduct capital losses from capital profits, and any tax year's nett capital losses can be carried forwards into subsequent tax years forever.
However, you are unable to deduct losses on investments from your regular income.
The ATO states that the majority of personal assets, such as your home, automobile, and the majority of assets that are used for personal use, such as furniture, are free from CGT. Depreciable assets that are utilised exclusively for taxable purposes, such as business equipment or fittings in rental property, are exempt from CGT as well.
If you are a resident of Australia, the CGT will be applied to any assets you own, no matter where they are located.
If a CGT event occurs on an asset that is considered "Australian taxable property," then foreign residents will either have a gain in capital or a loss in capital.
When you sell an item or get rid of it in some other way, this transaction is referred to as a CGT event. This is the point in time when you either realise a gain or a loss on your investment.
Establishing the timing of a CGT event is also essential since it tells you in which income year to report your capital gain or capital loss, and it may also alter how you calculate your tax due. Both of these things are important considerations when determining how to pay your taxes.
When you sell an asset subject to capital gains tax (CGT), the CGT event typically occurs when you engage into the contract for the asset's sale.
In the case of real estate, for example, the CGT event generally occurs when you enter into the contract - that is, the date on the contract, not when you settle.
Residing in the property to avoid paying capital gains tax
When it comes to real estate, one of the most important exclusions from the Capital Gains Tax that you can qualify for is if the property in question is your home or primary place of residence (PPOR).
Your home qualifies for an exemption from the capital gains tax known as the principle residence exemption.
In order to qualify for the exemption, the piece of property in question must contain a dwelling, and you must have occupied that dwelling at some point.
You do not qualify for the exemption that is available for unoccupied blocks.
In most cases, a house is regarded to be a person's primary residence if all of the following conditions are met:
- You reside there with your family.
- It contains your personal belongings.
- It is the address where your letter is sent.
- Your address is listed on the voter list, and
- There is connectivity between services like phone, gas, and power.
If you decide to convert your PPOR into a rental property, you may be eligible for an additional tax credit as a result of your decision.
There is a particular regulation that applies after six years, which states that in order for a property to continue to be free from CGT once it has been rented out for the first time, it must be sold within six years of when it was first rented out.
You are only eligible for the exemption if you do not occupy any other property as your primary residence at any given time.
The intriguing thing about this rule is that it restarts the six-year exemption period if you reoccupy the same dwelling as your primary residence after it has been vacant for at least six years.
Therefore, you are eligible for a further six years of exemption beginning on the day that it generates its next revenue.
if your primary residence is used for business, you must pay capital gains tax
Because of advances in technology, an increasing number of people are finding they can either work from home or go into business for themselves. Identified Male Signing a Contract
However, if a person works from home or uses their residence for business reasons, this may result in the imposition of a capital gains tax (CGT) of some kind. This is a situation that many people find themselves in.
Even if your job needs you to work outside of normal business hours, your home office will not be considered a place of business if your employer has an office in the same city or town in which you reside. This is something that you should keep in mind since it is vital.
Additionally, if you earn money from personal services in addition to other sources of income, you might not be eligible to deduct the costs associated with your place of residence.
When claiming your house as a business premise, it is vital to evaluate any potential consequences on your CGT obligations, as stated by the ATO.
In order to determine the amount of the non-taxable capital gain, you need to take into consideration a number of different elements, including the following:
- how much of your home's floor space is devoted to generating income.
- the time frame that you employ for this.
- which of the "absence" or six-year rules applies to you
- whether it was first employed to generate revenue after August 20, 1996.
Capital Gains Tax Avoidance Using a Self-Managed Super Fund
In recent years, there has been a significant increase in the number of funds as a direct result of the availability of the capacity to borrow money specifically for the purpose of investing in real estate through the mechanism of an SMSF.
According to the most recent numbers that have been made public by the Australian Taxation Office, there are currently close to 600,000 SMSFs that are active (for December 2015).
While people have generally always been able to buy a property through SMSFs, a few changes have been made recently. SMSFs can now borrow money to do so.
The decision to establish a self-managed super fund (SMSF) should not be made only for the purpose of purchasing a property through an SMSF; nevertheless, doing so may be an option for those individuals who desire increased control over their super.
In a similar vein, it is vitally important not to consider purchasing the property with an SMSF for the express purpose of avoiding or minimising the payment of CGT.
It should be compatible with your long-term investment strategy and fulfil a number of requirements for checks and balances related to your monetary future.
If you do choose to invest in property using an SMSF, the unique ownership structure provides several taxation benefits.
If you wait until you are retired to sell the property, you won't have to pay any capital gains tax on the property.
In addition to that, if you use the CGT discount method computation, you might receive a reduction of 33 percent.
It is necessary to comply with stringent borrowing terms in order to shift your superannuation funds into the property, and doing so can expose you to investing risks.
Some of the property risks associated with geared real estate bought via an SMSF include:
Higher costs - SMSF property loans can be more costly than other property loans, which must be factored into your investment decision. Home Finances
Cash flow - Because your SMSF is responsible for making loan repayments, the fund must constantly maintain an adequate level of liquidity, also known as cash flow, in order to meet the repayment obligations.
Difficult to cancel - If the property loan documentation and contract for your SMSF are not set up correctly, unwinding the arrangement may not be allowed, and you may be required to sell the property, which may result in substantial losses for the SMSF. If this occurs, you may be required to sell the property, which may result in substantial losses for the SMSF.
Possible tax losses - You won't be able to deduct any tax losses from the property from your other taxable income if you have it outside of the fund.
No improvements to the property are allowed since the SMSF property loan must be paid off before any changes to the property that might affect its character can be made.
Holding an asset for more than 12 months
While this isn't technically an exemption, if you buy an investment property and keep it for more than 12 months, you're entitled to a 50% discount on the amount of CGT payable. The discount is 33.3% for super funds.
Investing in affordable housing
From 1 January 2018, investors who invest in qualifying affordable housing will receive an additional 10% discount, bringing their CGT discount to 50%. To qualify, the investment property must be provided below-market rent and made available for tenants on low to moderate incomes. Registered community housing providers must also manage it, and the property must be held as affordable housing for a minimum of three years.
CGT Discount for Foreign Residents Individuals
If you are considered a foreign resident for purposes of taxes, you are subject to different laws regarding the individual capital gains tax (CGT). When you sell a residential home in Australia, these regulations will have an effect on you.
You will no longer be able to claim the CGT principal residence exemption after the 12th of December 2019, as a result of a change in the law. This is the case unless, at the time a CGT event occurred to your residential property in Australia, you had been a foreign resident for tax purposes for a continuous period of six years or less. One of the following could be said to have taken place during that time:
- you, your spouse, or your child under 18, had a terminal medical condition
- your spouse, or your child under 18, died
- the CGT event involved the distribution of assets between you and your spouse as a result of your divorce, separation or similar maintenance agreements.
This applies to you:
- when you change your foreign resident capital gains withholding rate because of the exemption
- your filing date for your income tax return
- you must declare any net capital gain in your income
- you can claim a credit for the foreign resident withholding tax paid to us.
When the change applies
For taxation reasons, the following changes are applicable to foreign residents:
- For property held before 7:30 pm (AEST) on 9 May 2017
- Only disposals that occur up until 30 June 2020 and only if they meet all other exemption requirements are eligible for the CGT principle residence exemption.
- The CGT principal residence exemption will no longer apply to disposals made after 1 July 2020 unless certain life events (described above) take place within a continuous period of six years of the person becoming a foreign resident for tax purposes.
For property acquired at or after 7:30 pm (AEST) 9 May 2017
- From that point forwards, unless specific life events (mentioned above) occur within a continuous period of six years of the person becoming a foreign resident for tax purposes, the CGT principal residence exemption no longer applies to disposals.
Note that this modification will only apply to you if, for the purposes of Australian taxes, you were not an Australian resident at the time that the disposal occurred (when you sign the contract to sell the property).
It is highly doubtful that you will be able to meet the conditions for the CGT principle residence exemption if you were not an Australian resident for tax purposes while you were living in your house.
If you are considered a foreign resident for purposes of taxes at the time of your death, the following modifications also apply to you:
- beneficiaries, trustees, and legal personal representatives of decedents' estates
- joint tenants who survive
- unique trusts for the disabled.
Up to 8 May 2012, the CGT discount of 50% was available to foreign resident individuals who were subject to CGT on Australian taxable property.
For assets acquired after 8 May 2012, the discount is generally not available to foreign and temporary resident individuals (including beneficiaries of trusts and partners in a partnership).
The discount is apportioned where a CGT event happens after 8 May 2012 and:
- you acquired the asset before that date, or
- you had a period of Australian residency after that date.
CGT events that occurred before 8 May 2012 are not affected.
Foreign and temporary residents
You must calculate the CGT discount you can apply to the capital gain if you're a foreign or temporary resident individual and, after 8 May 2012, you have a discount capital gain from a CGT event.
If you were a foreign or temporary resident on 8 May 2012, you might choose to get market value for the CGT asset as at 8 May 2012 and use a market value calculation. This will apportion the CGT discount to take into account the capital gain you accrued before 8 May 2012.
Frequently Asked Questions
- Holding onto an asset for more than 12 months if you are an individual. ...
- Offsetting your capital gain with capital losses. ...
- Revaluing a residential property before you rent it out. ...
- Taking advantage of small business CGT concessions. ...
- Increasing your asset cost base.