The Ultimate Guide on Capital Gains Tax for Property Investments

As a property investor, you’ve likely encountered the term capital gains tax (CGT). If you intend to sell your property investment at some point, there’s a high possibility that you’ll be liable to pay CGT. 

It’s not uncommon to hear 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 rewarding tax exemptions and concessions that you can use to maximise the value of your investments. 

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 Taxation Office (ATO), if you make a profit on selling your investment property, that profit is considered a capital gain. It must be declared on your income tax return. 

The capital gain is considered income, with particular rules on calculating it. 

Once the profit on a sale is calculated, it is added to your tax return. Capital gains tax, or CGT is the additional tax you must pay resulting from including capital gain on your tax return. 

 

When is A Dwelling Subject To CGT?

When a property is first established as a rental, it is subject to CGT when sold at a profit. Any capital gain earned on the sale of land, holiday houses, or other property not generating income is also subject to tax.

Remember that CGT is payable regardless of how the proceeds of the sale are used and regardless of what loan is outstanding at the time of sale.

 

How To Minimise Paying Capital Gains Tax When Selling Your Rental Property

Thankfully, the ATO does allow property investors to be exempt from paying capital gains tax in certain circumstances. 

What’s more, 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 absence  rule
• The six-month rule
• 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 your principal place of residence (PPOR) in some state 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.

Establishing the property as an MR requires the property to be occupied after settlement, including moving the family and furniture. Other indicators include the following: 

• Living in the property for the full duration that you’ve owned it
• Keeping your possessions at that property
• Using the address to receive your postal mail 
• Having all the property’s utility accounts in your name
• Updating the address to the electoral roll and driver’s licence

Where it is not possible to move in due to tenants continuing to lease the property, a partial CGT may apply when it comes time to sell the property. 

The Capital Gains Tax 6-Year Absence Rule 

The capital gains tax 6-year rule allows you to use your MR as an investment by generating income from it for up to six years after you move out, extending the MR exemption.`

So, just like homeowners who sell without prompting capital gains tax, you, as a person, can sell your property within six years and not have to pay CGT. 

Where the property is ‘re-established’ as the MR before the expiration of the six years, then an additional 6-year extension may be possible.

If sold after six years, that will be considered the exempt portion.

There are several conditions, including that no other property can be nominated as the main residence during that time.

 

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, giving you time to dispose of the old property without triggering CGT liability. There are also several conditions to comply with to get this exemption.

 

The 50% CGT Discount 

If you don’t qualify for any 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 can 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 marginal tax rate for that year because the capital gain forms part of your taxable income and is not a separate tax.

 

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 following: 

• CGT discount method
• 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 = net capital gain

 

Your property’s cost base takes into account, the following: 

• Purchase price
• Costsfor improvements and additions
• Depreciation claimed as deduction may be added back

 

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
• Renovation costs
• Sales agent commissions

 

Other things you should consider when calculating your cost base include the following: 

• For land and other non-income generating property purchased after 1991, the cost base will also include interest, rates and other maintenance costs. 
• For situations where a property was used both as a rental and a main residence, then the interest and rates incurred during the main residence period will add to the cost base, reducing the capital gain.
• Where it was first established as a main residence, the cost base of the property will be the market value when first rented.

 

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 use this method or the discount method to calculate capital gains tax, the discount method is more often used. 

 

Other Capital Gains Tax Considerations

Beyond how CGT is calculated and what potential exemptions may apply, there are a few other considerations you need to consider when it comes to capital gains tax on the sale of an investment property.

 

Intention

Should the ATO decide to audit your tax return, they may review the sale in hindsight. For example, if they determine that the facts show that the intention was that the property was always intended as a rental investment, that is how it will be treated for CGT purposes. 

 

More than One Owner

Where a property is owned by more than one person, CGT is split between them based on the title deed. If either person has no other income in the year in which the tax is derived, then the CGT will be lower.

 

Transfer of Property 

All CGT rules will apply regardless of whether or not the property is transferred to a relative or sold to someone at arm’s length. Regardless of whether or not money changes hands, the market value is considered the sale value.

 

CGT on Overseas Properties

Where the main residence was purchased in an overseas location, the same CGT principles will apply.

Where the homeowners were non-residents for tax purposes at the time, the main difference is that where the property was an investment property, its cost base would be the market value when the taxpayers became residents of Australia for tax purposes.

 

Residency Status

The residency status during ownership and at the time of sale also has a major impact on how the CGT is calculated and also the eligibility of any exemptions. 

 

Key Takeaways

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’s 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,  get in touch today!

 

FAQs

What are Capital Losses?

A capital loss occurs when you dispose of a capital gains tax (CGT) asset for less than its cost base. This includes both realised losses, where you actually sell the asset for less than you paid, and unrealised losses, where the asset decreases in value but you continue to hold it. Capital losses can be used to offset capital gains to reduce your overall CGT liability.

 

Do You Pay Tax When You Make a Capital Loss?

No, you don’t pay tax on capital losses themselves. However, capital losses can be used to offset capital gains, which decreases the amount of capital gains tax you need to pay. When you report a capital loss, it offsets your taxable capital gains for that financial year. If your capital losses exceed your capital gains, you can carry the unused capital losses to future years to offset future capital gains.

 

What is My Income Tax Rate?

Personal income tax rates in Australia are progressive, meaning higher incomes are taxed at higher rates. In addition, the Medicare levy of 2% generally applies to all taxable incomes. Your exact income tax rate will depend on your total taxable income for the year. The ATO online tax calculator can help you estimate your personal tax rate.