If you sell your investment property, and make a profit, you are liable for a government tax called capital gains tax (CGT).
As capital gains tax is only paid once the asset is disposed of, you are able to use some of the proceeds from the sale to pay it.
Read this guide to help you understand the rules around capital gains tax - including what it is, how much it is and when it gets paid. This article will help you understand:
A capital gain is the profit you get from the sale of an asset, like an investment property.
Capital gains tax - or CGT - is a government tax on this profit (gain). It is calculated by subtracting the cost involved in owning your property from the proceeds of the sale. You can also make a capital loss, when you sell your investment property for less than you initially paid for it.
Capital gains tax applies to any asset that was purchased on or after 20 September 1985, the date this tax came into effect. You are only liable to pay capital gains tax on a property that is not your primary residence. Any profit you make from the sale of an investment property is part of your annual income tax assessment, and is added to your taxable income in the year you sold the property.
Let’s now understand how you go about calculating your capital gain.
The easiest way to work out the capital gain is to take the selling price of your investment property and subtract the original cost and certain expenses you incurred when buying, holding and selling your investment property, such as rates, land taxes, renovation expenses, repair costs, insurance premiums, etc. The remaining amount is your total capital gain or loss.
Example: You purchase an investment property for $500,000, and you incurred costs of $18,500 when you acquired, held and eventually disposed of the asset. If you end up selling the property later for $700,000. The capital gain would be $181,500.
Keep detailed records of all expenses related to your investment property. This will make it easier for you to work out if you made a capital gain or loss in a tax year.
Now let’s look at how you work out your capital gains tax.
The amount of capital gains tax you pay depends on two factors, your marginal tax rate and the amount of gain or profit you earned from the sale of your investment property.
Capital gains tax is not taxed separately in Australia, so there is no specific rate of tax applied. Instead the gain - or profit - is added to your overall income for the tax year, so your final tax rate will depend on your personal marginal tax rate.
Many property investors choose to get advice or help from a professional, like a tax accountant - as the rules around CGT can be complex. With this in mind, here are three methods for working out your capital gain. To maximise your ROI, and the amount of tax you pay, you should choose the method that gives you the smallest capital gain.
This method is for any assets purchased prior to 21 September 1999, and which you have held for 12 months or longer. The calculation is based on an indexation factor that uses the consumer price index (CPI) for the period up to that date.
If you hold any capital gains tax asset for longer than 12 months you will get a 50 per cent discount on your capital gain. Note: If you sell your investment property within 12 months of purchase, you will pay tax on the full capital gain.
If you have held your investment property for less than 12 months, then you can simply subtract all your expenses associated with holding it from the cost of purchase.
Let’s now look at strategies to legitimately avoid or minimise how much capital gains tax you pay.
As an investor there are a number of ways you can minimise the capital gains tax you pay. These can be divided into full exemptions - where you avoid paying any capital gains tax; and partial exemptions - where you avoid paying some capital gains tax.
The following are scenarios where you will avoid paying any capital gains tax:
The following are scenarios where you will pay some capital gains tax:
What happens if you make a loss from the sale of your rental property?
If you have made a loss from the sale of your investment property, you can use it to reduce the tax from other capital gains. The ATO also allows you to carry forward net capital losses forward indefinitely, so you can claim these in a future tax year - They don’t allow you to deduct capital losses from your taxable income.
When calculating your capital loss, you need to use the property’s “reduced” cost base. To find this, you simply adjust the normal cost base for any balancing adjustments (e.g. improvements you’ve made to the property)
As you can see capital gains tax is a complex area of Australian taxation law, so we recommend getting a tax specialist to help you. They can help you minimise the amount of CGT you pay, which helps to maximise the ROI from your investment.
Have any questions about CGT - or anything else? We’re happy to help, and our local team are available to chat at a time that suits your schedule.