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What is capital gains tax?

Capital gains tax (CGT) is the tax levied on the profits made from selling or disposing of assets, including investments like real estate, stocks, and cryptocurrencies. Despite being termed 'capital gains tax,' it is actually incorporated into your income tax, rather than being a separate tax.

When you dispose of an asset-meaning you no longer own it-a CGT event is triggered. At this point, you must report any capital gains or losses in your income tax return.

Here are the implications:

• Capital Gain: If you realise a capital gain, your taxable income will increase, resulting in a higher tax liability. It is advisable to calculate the expected tax and reserve funds to cover it.
• Capital Loss: If you incur a capital loss, you can offset it against any capital gains in the same year to reduce your tax liability. If your losses exceed your gains, you can carry them forward to offset gains in future years. It is crucial to report these losses on your tax return.

What is the CGT rate?

The CGT rate varies depending on the type of taxpayer and their circumstances.

Individuals

For individuals, there is no specific CGT rate in Australia. Instead, capital gains are added to their assessable income and taxed at their marginal tax rate. This means that the amount of CGT an individual pays depends on their total taxable income for the year, which could place them in different tax brackets. It's also worth noting that individuals may be eligible for a 50% discount on capital gains if the asset was held for more than 12 months.

Companies

For trading companies, the CGT rate is determined by their annual turnover:

• Companies with an annual turnover of less than $50 million pay a flat CGT rate of 26%.
• Companies with an annual turnover exceeding $50 million are taxed at a flat rate of 30%.

Self-Managed Super Funds (SMSFs)

Self-managed super funds (SMSFs) are subject to a CGT rate of 15%. However, if the fund is in the pension phase, capital gains may be exempt from tax.

Investment Companies

Investment companies that are not eligible for the 26% rate applicable to trading companies with turnovers below $50 million are taxed at a flat rate of 30%.

How to calculate capital gains tax on an investment property

Calculating CGT on an investment property involves several steps and considerations. Here's a detailed guide to help you understand and potentially reduce the amount of CGT you may have to pay.

Step-by-Step Calculation

1. Determine the Cost Base: The cost base is the original purchase price of the property plus any associated costs, such as stamp duty, legal fees, and any capital improvements made to the property.

2. Calculate the Capital Proceeds: This is the amount you receive from the sale of the property.

3. Calculate the Capital Gain: Subtract the cost base from the capital proceeds. If the result is positive, you have a capital gain. If negative, you have a capital loss.

4. Apply CGT Discounts and Exemptions:

   • 50% Discount for Individuals: If you've held the property for more than 12 months, you can reduce your capital gain by 50%.

   • 60% Discount for Affordable Housing: If you invest in qualifying affordable housing, you may be eligible for a 60% CGT discount.

Strategies to Reduce CGT

1. Hold the Property for Over 12 Months: As an individual, you can reduce your CGT by 50% if you hold the property for more than a year.
2. Re-evaluate Your Property Before Renting It Out: If you convert your residential property to a rental, have it re-evaluated at the time of conversion. You will then only be liable for CGT on the gain from the time it was re-evaluated, not from the original purchase date.
3. Invest in Affordable Housing: The Australian government provides an additional CGT discount for investments in affordable housing. As of January 2018, qualifying investments may receive up to a 60% CGT discount. To qualify, the property must be rented to low or moderate-income tenants at a rate below the market rental rate.

CGT-Exempt Assets

Some assets are exempt from CGT, including:

• Assets Purchased Before 20 September 1985: These are considered pre-CGT assets and are exempt from CGT.
• Your Main Residence: The home you live in is generally exempt from CGT.
• Personal Vehicles: Cars, motorcycles, and similar vehicles are exempt.
• Depreciating Assets in an Investment Property: Items such as appliances and furniture used in a rental property may be exempt from CGT.

Example Calculation

Suppose you bought an investment property for $500,000, including all associated costs. After 15 years, you sell it for $900,000. Your capital gain is:

Capital Gain = $900,000 − $500,000 = $400,000

If you've held the property for more than 12 months, you can apply the 50% discount:

Taxable Capital Gain = $400,000 × 0.5 = $200,000

This $200,000 will be added to your assessable income for the year and taxed at your marginal tax rate.

Capital Gains Tax Calculator

Our Capital Gains Tax Estimator provides an indication of the amount of capital gains tax you may be required to pay on an investment property. Under the Capital Gains Tax legislation which came into effect on the 30th of September, 1999, it is possible for an individual to calculate the CGT they will have to pay in one of two ways. We call these the "old" and "new" regimes.

The old regime, introduced in 1985, calculates CGT by indexing capital gains to take account of inflation during the period the asset was owned. To determine the amount of capital gains tax payable the indexed capital gain is then treated as income and the investors marginal tax rates apply.

The new regime, introduced on 30th of September, 1999 calculates CGT by applying the individual's marginal tax rate to half of the total capital gain. There are a large number of rules relating to capital gains tax, particularly concerning what are acceptable deductions. You should only include costs which can legitimately be deducted for taxation purposes.

Important things to remember

1. Fees for tax advice are only taken into account when incurred after 30 June 1989, and when advice was provided by a recognised professional tax adviser.
2. Capital improvements are defined as capital expenditure incurred to increase the value of the CGT asset, if the expenditure is reflected in the state or nature of the asset at the time of sale.
3. Among other capital costs include any capital expenditure you incur to preserve or defend your title or rights to the asset.
4. If the payment you receive for an item making up part of the asset is greater than its depreciated value, it will be necessary to adjust the cost base. This is done by subtracting the sum of the depreciation and the balancing amount. (The balancing amount is equal to the difference between the sale cost of the item and its depreciated value.)
5. Under the old capital gains tax regime it used to be that indexing was calculated over the full period between purchase and sale. It is now the case that the capital gain is only indexed over the period between purchase and 30th of September, 1999.
6. Capital losses can only be used to offset other capital gains for tax purposes. It is not possible to use capital losses to reduce taxable income from other sources.
7. For more information about capital gains tax and investment properties visit the Australian Taxation Office website.