Capital Gains Tax Explained
Property investors are rewarded with plenty of tax breaks to benefit from, but investments are hard work and additional taxes must be paid, such as council property rates and Capital Gains Tax.
Capital Gains Tax can be a complex topic for both investors and homebuyers so understanding the legislation is key in making sure you get the most out of your property.
If you plan to hold your property for the long-term, you’ll need to pay tax on any capital gains. Although many investors focus on the positive impact of tax deductions, the potential impact of Capital Gains Tax you’re liable for come sale time are costly. However, there are ways to maximise deductions and save tax on an investment property.
Here’s what you need to know about capital gains tax and how to minimise what you pay.
What is Capital Gains Tax?
Rental yields and capital gains are how returns are made with property investment.
Rental yield is the amount of income generated by the property, capital gains are from profits made when selling.
Capital Gains Tax (CGT) is an amount that must be paid on these profits from the sale of an investment, such as a rental property or plot of land. CGT isn’t a separate tax; it’s assessed as part of your annual income tax.
Generally, CGT only applies to properties that aren’t the home you live in. This includes investments such as houses, apartments and commercial or industrial properties.
CGT is also payable when buying and selling other assets like shares, licenses and foreign currency. Most personal assets, including your home and car, are exempt.
Costs to consider
CGT rates are the same as income tax rates. But if you’ve owned the property for more than 12 months, ATO offers a 50% discount on the capital gain.
Payments are made in the financial year which you sell or dispose of your investment property.
How is Capital Gains Tax calculated on property?
If you’re selling an investment property, CGT is calculated on the sale price minus expenses.
These expenses, your ‘cost base’, include the original purchase price and any ownership, title, renovation and incidental costs. For example, stamp duty, kitchen/bathroom renovation, land taxes or home loan interest fees. Government grants and depreciable items are taken off.
There are three methods to calculate your capital gain
- CGT Discount Method: Benefits property investors but not companies. Individuals and trusts receive 50% if they hold assets for 12+ months.
- Indexation Method: More complex and only applies to properties purchased before 21st September 1999.
- Other: If you’ve owned your property less than a year, you’ll have to pay the full CGT. TO calculate how much, subtract your cost base from capital profits.
Capital losses can be deducted from your capital gains to reduce how much tax you pay. If you don’t have other gains in that income year, carryover losses to other income years.
Tip: To reduce your CGT, keep all receipts relevant to the property purchase and improvement. The higher you can prove you spent, the better your cost base and the lower your capital gain.
Buy, renovate and hold strategy
Your strategy and set up process impacts CGT.
If you sell your investment property on completion of the project (within a 12 month period), CGT will wipe out the bulk of your hard-earned growth. Depending on your income bracket, this amount could be almost half of your profits.
According to Cherie Barber from Renovating for Profit, it’s better to buy, renovate and hold. Instead of losing half your profits to tax, you hold onto the property longer to gain capital growth before selling it.
Other strategies to minimise your CGT include:
- Move-in right away, as your main residence is exempt from CGT all profits will be yours when you sell.
- Move-in later. If you originally rent out your investment property then decide to move in, you’re entitled to a partial exemption.
- Use your self-managed super fund to purchase the investment property and home loan, and pay off with super contributions.
- Smart renovations. Property improvements that add value manufacture capital growth and reduce your capital gains, just make sure to record, track and keep all receipts.