While capital gains tax might sound overwhelming at first thought, with a bit of knowledge and planning, it’s possible to substantially reduce how much of it you pay – or even avoid it altogether.
What is capital gains tax
Capital gains tax (CGT), for those who are new to this, is the levy you pay on the capital gain made from the sale of that asset.
A capital gain (or loss) is the difference between what you paid for an asset and what you sold it for (less any fees incurred during the purchase). So, if you sell a property for more than you paid for it, that’s a capital gain. And if you sell it for less, that is considered a capital loss.
While it is always best to seek professional advice on how the law relates to your specific situation, this guide provides some handy information to set you on your way.
When do you have to pay capital gains tax on a property?
Generally, if a property is sold for a gain, capital gains tax (CGT) will apply. But there are always exceptions. For example, no CGT applies if the property is a person’s main residence, i.e. their home.
Another common exception is if the property was purchased before September 20, 1985. But keep in mind that any significant improvements or renovations made since that date may be treated as a separate asset under law and consequently subject to CGT.
Meanwhile, small business concessions on CGT may also apply if the property is used in relation to a business and the taxpayer passes a variety of tests.
How are capital gains calculated on property?
To quickly calculate your capital gains just subtract the original price of the property from the selling price, the remainder is your capital gains amount.
Brendan Dixon of Pure Finance says gross capital gain can be defined as the sale price, minus the purchase price and associated costs.
When a property has been held for more than 12 months, a 50 per cent discount is generally applied to the gain. However, companies are not entitled to this discount, nor foreign residents who bought their property after 8 May 2012, and self-managed super funds only get a discount of one third.
Dixon adds that you need to factor into your CGT estimations any other income you earn during the year in which you sell your property, as your marginal tax rate will affect how much CGT you ultimately pay. This is because CGT is not really a separate tax, but rather part of your income tax considerations.
How much is capital gains tax in Australia
For individuals capital gains tax is calculated at the same rate as your income tax. If you own the asset for more than twelve months, however, then you’ll receive a 50% discount.
How to avoid capital gains tax on your property
There are a number of concessions and exemptions when it comes to paying capital gains tax, and numerous strategies designed to reduce your overall tax bill, too.
Here are some of the main strategies used to avoid paying CGT:
- Main residence exemption
- Temporary absence rule.
- Investing in superannuation.
- Timing capital gain or loss.
- Partial exemptions.
- CGT does not apply if you owned the asset before CGT started on 20 September 1985
1. Use the main residence exemption
If the property you are selling is your main residence, the gain is not subject to CGT. However, the exemption may not fully apply if the residence has been used to produce income. In this case, a portion of the capital gain will be taxable.
2. Use the temporary absence rule
An extension of the main residence exception, the temporary absence rule applies to a situation where you move out of your main residence.
You can continue to treat the property as your main residence indefinitely, or for up to six years if you initially buy a property as your main residence and later rent it out. And if you move back into the rented property within the six years, the period is reset and can be treated as your main residence for another six years.
3. Invest in superannuation
While self-managed super funds only attract a one-third discount for CGT, the standard tax rate for funds is only 15 per cent, meaning the maximum CGT rate is 10 per cent. Which is lower than most people’s marginal tax rate.
Dixon adds that if a self-managed super fund member starts a full retirement pension from the assets of the fund, this applicable rate drops to zero.
4. Get the timing of your capital gain or loss right
A simple strategy to reduce CGT is to consider the timing of when you make a capital gain or loss. If you know your income will be lower in the next financial year, you can choose to delay selling until then, so that your lower marginal tax rate results in you paying less CGT.
Timing loss can be beneficial, too. Dixon gives the example of a person expecting to make a capital gain from a sale, who also holds shares that are trading at an unrealised loss lower than the capital gain. The person may consider selling the shares before the sale, so they can deduct the loss from their capital gain.
5. Consider partial exemptions
Holding a property for more than 12 months will attract a 50 per cent discount in CGT, and you can also receive a partial exemption if you move into a rental property.
You are still entitled to a reduction in CGT if you use your main residence as a place of business, too.
Meanwhile, investing in affordable housing can attract a 60 per cent reduction in CGT – so long as the housing meets certain criteria and the rent is charged at a discounted rate.
Dixon adds that capital losses can also be applied against your capital gains, but not against your ordinary income.
As ever, though, make sure you seek professional advice to get the best outcome for your specific situation.
Does CGT apply on inherited properties?
No, generally capital gains tax does not apply to inherited properties. However, it may apply once this property is sold if it’s not your main residence.
Does CGT apply if you transfer or gift a property?
Gifting property is a little more complicated when it comes to capital gains tax and will depend on the situation. For example, if the property is part of a relationship breakdown then it may be exempt if it’s being transferred to a former spouse.
For the giver
If it was your main residence then it’s exempt, but if not then the amount applicable for CGT will be the market value, not the amount you gifted it for.
For the receiver
Generally you’ll only have to pay CGT when you go on to sell the property, provided it’s not your main residence.