Navigating the capital gains tax minefield
Capital gains tax is a minefield and knowing how to tip-toe through the maze unscathed is a crucial component of any successful property portfolio and investment strategy.
For many investors, the idea of handing over a sizeable chunk of a property sale profit to the Australian Taxation Office (ATO) is overwhelming, disheartening or even unjust.
However loathed it may be, CGT is a fundamental part of the property investment journey, so it pays to understand it and have a grasp of some ways to minimise its impact.
CGT is a tax on the capital gain made from the sale or disposal of assets, such as real estate, shares, and investment properties. The ATO considers most assets acquired after 20 September 1985 to be subject to CGT, although some exemptions apply.
Sydney-based Tax Manager for Australasian Taxation Services, Annie Zhu, said navigating the CGT landscape could be tricky and there were significant differences in how the tax was applied for resident and non-resident Australians.
“For tax residents, there’s a CGT discount applicable when the investment property is held for more than a year,” Ms Zhu said.
So far, so straight forward – until you move overseas.
“CGT discount is not available to foreign and temporary tax resident individuals for assets property held or acquired after 8 May 2012,” she explained.
“We need to use the market value on 8 May 2012 to calculate the CGT discount proportionally based on the number of days for those two separate periods when the property is held in Australia and while overseas.
“If there was no market value provided on 8 May 2012, during the periods of holding the property as a non-tax resident or temporary tax resident it is not eligible for any CGT discount.”
Calculating CGT
To calculate the capital gains tax liability, you need to determine the capital gain made from the disposal of an asset. The capital gain is generally the difference between the asset’s cost base (the purchase price, including associated costs) and the proceeds received from the sale.
The formula for calculating CGT is as follows:
Capital gain = sale proceeds - cost base
The tax is then applied to the capital gain at an individual’s marginal tax rate.
A CGT case study
Capital gains tax case for David, the returning expatriate
- David purchased a residential property for $500,000 on 5 July 2001.
- He moved to Hong Kong on 6 March 2003 and rented out the property, when the market value of the property was $650,000.
- The market value of the property on 8 May 2012 was $850,000.
- He returned back to Australia and became a tax resident on 24 May 2018 and the property continued to be rented out as an investment property.
- On 21 June 2022 he signed the sale contract and sold the property for $1.25 million, and settlement occurred on 1 August 2022.
The CGT outcomes for David
| Dates | Gross Capital Gain | Net Capital Gain | |
|---|---|---|---|
| 5/7/2001 - 6/3/2003 | Property lived in (disregarded) | $0 | $0 |
| 7/3/2003 - 6/3/2009 | Main Residence CGT Exemption (six years absentee provision) |
$0 | $0 |
| 7/3/2009 - 7/5/2012 | CGT discounted | $69,180 | $34,590 |
| 8/5/2012 - 23/5/2018 | CGT non-discounted | $238,800 | $238,800 |
| 24/5/2018 - 21/6/2022 | CGT discounted | $161,200 | $80,600 |
| Total | $469,180 | $353,990 |
CGT exemptions and concessions
As Ms Zhu highlighted, there are variations to the amount of tax applied based on a range of factors surrounding the property in question.
The first rule to know is that the primary place of residence (PPOR) is not subject to CGT.
Eligible small business owners may be entitled to various concessions, such as the 15-year exemption, 50 per cent active asset reduction, retirement exemption, and small business rollover.
These concessions aim to support entrepreneurship and encourage investment in small businesses.
For assets acquired before September 20, 1985, capital gains before this date are generally exempt. However, subsequent improvements made to the asset after this date may be subject to CGT.
Ms Zhu said the CGT six-year rule also offered a way out of paying CGT for some landlords while still earning rental income.
The rule allows owners to use their PPOR as an investment, by renting out for a period of up to six years. The caveat here is that it only applies if not deeming another property to be the main residence, as the ATO will only permit one CGT exempt main residence at a time.
If the property is sold within the six years, the owner would be exempt from paying CGT as they would if they sold the house they primarily lived in.
The benefit of the rule appeals to homeowners who want to make some extra money for the time that they are not, for whatever reasons, able to stay in their home - without prompting the need to pay CGT upon its eventual sale.
When a rental or investment property is sold at a loss position, those capital losses can only be used to offset/decrease any capital gains but not the ordinary income.
Determining the cost base
If the property was purchased as an investment property, the cost base is the original purchase price plus any other relevant expenses.
If the property was instead purchased as a main residence, and was subsequently rented out as an investment property, then the ATO resets the cost base of the property to be the market value of the property on the date when it became an investment property. Any initial purchases costs are accordingly disregarded.
If the property was sold as a non-resident, the main resident exemption is not applicable. This means the CGT is calculated from day one (the initial purchase price will be the cost base) regardless of whether the property was used as a main residence property previously or not. The six-year absentee provision does not apply either in this case.
Understanding the calculation methods, exemptions and concessions available is crucial for taxpayers to effectively manage their tax obligations.
By staying informed and seeking professional advice when necessary, taxpayers can navigate the complexities of CGT while ensuring compliance and optimising tax outcomes.
