CAPITAL GAINS TAX AND YOUR INVESTMENT PROPERTY

Buying and selling an investment property does not only involve annual rental income or loss, you also have to keep in mind the tax you have to pay when you sell it. This tax is one of the biggest taxes and is called Capital Gains Tax (CGT).

Despite the commonly used acronym and its widespread impact, a lot of people don’t really know what CGT is, let alone how it will affect them.

Almost daily, I come across clients that have a change of mind or direction during ownership of their home which then potentially raises the CGT issue. Careful planning will ensure you don’t get caught out with a big tax bill when one day, you decide to sell.

If you own, or are thinking about purchasing an investment property it’s important to know how you’ll be affected. In this article we’ll outline what CGT is and how to calculate it, so no one’s surprised when the taxman (or woman) comes a-calling.

What is Capital Gains Tax?

Capital Gains Tax was introduced in Australia in 1985 and applies to any asset you’ve acquired since that time, unless specifically exempted.
When you buy most financial assets like shares or commodities, you are doing so in the hope that you will later be able to sell them on at a profit. When that profit is incurred it is usually subject to CGT.

When you sell or otherwise dispose of an asset it’s called a CGT event, which is the moment when you make a capital gain or capital loss. When it comes to property, CGT is usually only considered by property investors as the tax only applies for investment purchases and not your owner-occupied residence. It usually occurs at the date of the contract of sale and needs to be declared in your tax return in the same year.

How do I work out my CGT?

CGT is based on the difference between the selling price and the purchase price, which can include the sum paid for the property plus legal fees, stamp duty and other upfront costs as well as the value of any capital improvements (renovations) completed by you.

Let’s look at an example – assume you purchased an investment property for $500,000, 8 years ago and the purchase costs (e.g. stamp duty, etc.) were $25,000. The total cost was $525,000.

Today, you sell the property for $750,000. Your net proceeds (e.g. after agent costs, marketing, and the like) are $725,000.
The Capital Gain in this instance is $200,000 (i.e. $725,000 less $525,000).

A Capital Gain occurs when the Sale Price (net of selling costs) is greater than the Cost Base (which is made up of the purchase price plus transaction costs). This example assumes no depreciation has been claimed during the 8 year ownership period. If depreciation was claimed, this amount should be deduced from the Cost Base.

With regards to a property investment, the principal CGT exemptions include:

1. 50% discount for Investors
2. 6 year rule
3. 6 month rule

1. 50% Discount for Investors

For properties purchased after October 1999, a discount of up to 50% may be available on the capital gain calculated for tax purposes (eligibility is dependent on the ownership structure of the investment- see your tax accountant for more information).
If an investment property is held for 12 months or more, you are entitled to a 50% discount should you dispose/sell the property one day. In other words, the Capital Gain is halved before tax is applied. The 12 months is worked out from contract date and not settlement date.

2. The 6 year rule

This is a handy rule to know as I have seen many of our clients move out of their PPOR for a while due to work relocation (e.g. interstate or overseas). Rather than keeping your home empty collecting dust, many people choose to rent it out and collect rental income.
If a property was your PPOR when acquired, you are entitled to a full CGT exemption. If you move out of the property and rented it out, you can claim an exemption from CGT for a period of up to six years after moving out. The Australian Taxation Office (ATO) lists some of the qualifying reasons for a property owner to move from their PPOR as: accepting a new job interstate or overseas, staying with a sick relative long term or going on an extended holiday. If you decide to move back into the property and afterwards moves out again then a new six year period commences from the time you last moved out.

3. The 6 month rule

This rule applies when you upgrade or purchase another home. If you buy a new home before selling your existing home, you’ll get the CGT exemption so long as you dispose of your older home within 6 months of purchasing the new home.

Other conditions that apply to this rule are:
The older home was your PPOR for a continuous period of 3 months (within the last 12 months before you sold it)
The older home was not tenanted during the last 12 months before you sold it
The new home becomes your new PPOR

In summary, CGT is usually only concerned by property investors, however as you can see from the information above, you should be across the detail in case your situation changes and there is a need to change the intent or usage of your PPOR.

For an honest and unbiased opinion, talk to Think and Grow Finance today on 03 8390 5855 or email mitesh@thinkandgrowfinance.com.au

*Please note – Think & Grow Finance does not provide tax advice and the article above is general information only. Readers should always assess their situation accordingly and seek tax advice with a qualified taxation adviser.