The Ultimate Guide on Capital Gains Tax for Property Investments
As a property investor, you’ve likely come across the term capital gains tax (CGT).
If you intend to sell your property investment eventually, there’s a high possibility that you’ll be liable to pay CGT.
It’s not uncommon to hear that investors get completely overwhelmed at the thought of potentially having to pay thousands of dollars in tax on their hard-earned investment profit.
However, there are a few lucrative tax exemptions and concessions that you can use to maximise your investments’ value.
So, it’s generally helpful to have a good understanding of capital gains tax and how to minimise it. This way, you’ll be prepared when it comes time to sell your investment property.
Here’s what you need to know.
What is Capital Gains Tax (CGT)?
According to the Australian Tax Office (ATO), if you make a profit on the sale of your investment property, that profit is considered a capital gain and must be declared on your income tax return.
The capital gain is considered income, with particular rules on how to calculate it.
Once profit on a sale is calculated, it is then added to your tax return. The additional tax you have to pay resulting from including capital gain on your tax return is known as capital gains tax or CGT.
How To Minimise Capital Gains Tax When Selling Your Investment Property
Thankfully, the ATO does allow property investors to be exempt from paying capital gains tax in certain circumstances.
What’s more is that if you don’t qualify for one of the exemptions, there are also alternative ways to reduce your CGT liability significantly.
These exemptions and concessions include:
- the Main Residence (MR) exemption
- the capital gains tax property 6-year rule;
- the six-month rule; and
- the 50% CGT discount.
The Main Residence Exemption
If you’re an owner-occupier of a property, as a general rule, that property will be your main residence in tax legislation or principal place of residence (PPOR) in some State’s legislation.
As you won’t typically generate an income from living in your own home, the ATO allows you to be exempt from paying CGT should you decide to sell that property.
To qualify for the MRexemption:
- you must live in the property for the full duration that you’ve owned it;
- you’re known to keep your possessions at that property;
- you use the address to receive your postal mail; and
- all the property’s utility accounts are in your name.
The Capital Gains Tax 6-Year Rule
The capital gains tax 6-year rule allows you to use your MR as an investment by generating an income from it for a period of up to six years.
In other words, you can use your investment property as if it was your MR for a period of up to six years and still rent it out.
So, just like home-owners who sell their family without prompting capital gains tax, you, as a property investor, can sell your property within six years and not have to pay CGT.
The Capital Gains Tax 6-Month Rule
Suppose you’ve bought a new home and haven’t been able to dispose of your old property.
If that is the case, the ATO will allow you to hold both properties as your MR for up to six months so that you have some time to dispose of the old property without triggering CGT liability.
The 50% CGT Discount
If you don’t qualify for either of the three exemptions listed above, the ATO still offers you a way to reduce the amount of CGT you pay significantly.
If you have owned your investment property for at least 12 months before selling it, you’ll be allowed to claim a 50% discount on your capital gains tax.
How Much Is Capital Gains Tax?
If you’re an individual property investor, the capital gains tax rate you’ll pay is the same as your income tax rate for that year because the capital gain forms part of your taxable income.
How To Calculate Capital Gains Tax
There are two primary methods that the ATO proposes you use when calculating the amount of capital gains tax you’ll be liable for. These include:
- the CGT discount method; and
- the indexation method.
To use one of these methods, you’ll need to understand how the sale’s capital proceeds are calculated.
To calculate your capital proceeds, you’ll need to subtract your property’s cost base from the selling price of your investment property:
Asset sale price – cost base = capital proceeds
Your property’s cost base takes into account:
- the purchase price;
- expenses; and
It’s worth noting the expenses you can add to your cost base because it’ll reduce the capital proceeds and ultimately help reduce the amount of CGT payable. Some expenses include:
- stamp duty
- legal fees; and
- renovation costs.
The CGT Discount Method
The CGT discount method is used to calculate your capital gains tax liability if you qualify for the 50% discount:
Sale Proceeds – Cost Base = Capital Gain x 50% = Taxable Capital Gains
For example, if your capital gain amounted to $72,000 at the CGT event and you’ve held the property for four years, you can apply the 50% CG discount and only pay $36,000:
$72,000 x 50% = $36,000
The Indexation Method
If you purchased your investment property before 21 September 1999, you could increase the cost base by an indexation factor.
The purpose of this method is to avoid paying capital gains tax on the portion subject to inflation.
The calculation works as follows:
Calculation of Indexation Factor
Consumer Price Index (CPI) for Quarter of CGT Event ÷ Consumer PriceI for Quarter when Expenditure Occurred = Indexation Factor
An indexation factor is applied to each element of your cost base.
Then you’ll multiply your capital proceeds by the indexation factor to calculate your capital gain:
Capital Proceeds x Indexation Factor = Capital Gain
While you can either use this method or the discount method to calculate capital gains tax, the discount method is more often used. The ATO offers this worksheet that you can use to calculate both methods and see which outcome is better for your circumstances.
If you’re thinking of selling your investment property, it helps to know about capital gains tax when you’re likely to be liable for it and an estimate of how much it is likely to be.
To maximise the value of your investment property and minimise the amount of CGT you have to pay, you should:
- take advantage of any of the ATO capital gains tax exemptions and concessions (especially the capital gains tax 6-year absence rule);
- add all applicable expenses to your cost base to reduce your taxable income when calculating CGT; and
- consult with a Property Tax Specialist if you’re feeling unsure if you qualify to minimise paying capital gains tax.
At Property Tax Specialists, our qualified tax agents can help you navigate through capital gains tax on the sale of your investment property. If you’re still uncertain or wish to seek professional advice on your circumstances, get in touch today!