From accumulating wealth, to providing a nest egg for retirement, purchasing an investment property has many benefits but there’s a sting in the tail when you sell - Capital Gains Tax (CGT).
The profit or ‘capital gain’ you make from the sale of the property is taxable income and is calculated by minusing the cost base (the original purchase price plus incidentals, ownership, improvement and title costs) from the sale price.
But don’t worry, CGT only applies to capital asset items - for instance, you won’t have to pay CGT if you get a profit when selling the family home or when you sell your car.
However, there are exceptions, such as if you rented out your family home for a period of time or the land you own is over two hectares.
Working out your Capital Gains Tax (CGT)
If you want to apply a number of exemptions, working out your CGT for an income tax year is best left to an accountant. Keeping good records and supporting documentation is essential to backup your claim.
But if your situation is straightforward you can work out if you have a capital gain or a capital loss yourself by following the methods on the ATO website - and “choose the method that gives you the best result – that is, the smallest capital gain.”
There are three methods of working out a capital gain and one method for capital loss:
- CGT discount method - if you sell an investment property after holding for 12 months you may be eligible for a 50% discount on your capital gain.
- Indexation method - if you sell an investment property you bought before 11.45am on 21 September 1999, you can increase the cost base by using a consumer price index (CPI).
- Less than 12 month ownership method - if you sell an investment property after holding for less than 12 months you simply just subtract the cost base from the capital proceeds.
The final amount of your capital gain is included in your income tax return and taxed at your marginal rate.
The rub is that a sizeable capital gain can significantly increase the amount of tax you have to pay and even push you into the next tax bracket so you end up paying income tax at a higher rate. But if you know how minimise your exposure, CGT can be managed to best advantage.
How to avoid Capital Gains Tax (CGT)
While you may not be able to avoid CGT completely if you sell at a profit, there are strategies you can adopt to save money - the following are just a few of these:
- Move in yourself straight away - main residences are exempt from CGT so you can claim a partial exemption if you move in when you first buy your investment property. You can also claim a partial exemption if you move in for a period of time at a later date.
- Choose your main residence wisely - if you own more than one property you can get them valued by a local real estate agent then nominate the property with the higher capital gain as your primary place of residence.
- Renovate - while we don’t advocate CGT avoidance as the main reason to renovate it can be a side advantage if you’re looking to add value to your property. Any costs you incur can reduce your capital gain - note: initial repairs are not allowed to be claimed as CGT deductions.
- SMSF (self managed super funds) - capital gains can be taxed at a discounted rate if you purchase an investment property as a SMSF asset.
For more information on capital gains tax check out the ATO’s 2017 guide.
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Disclaimer: Bricks+Agent recommends seeking advice from a professional in the financial sector if you need help to calculate your capital gains tax.