Capital Gains Tax and how it affects your property investments blog image

Capital Gains Tax and how it affects your property investments

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Capital gains tax may seem intimidating from a distance. However, it’s not as complicated as you might actually think. Let’s briefly discuss its definition and how to work it out.

What is capital gains tax?

Capital gains tax (CGT) is the tax you pay on a capital gain produced from selling an asset. Capital gain, on the other hand, is the difference between what you spent for an asset (subtracting any expenses incurred throughout the investment), and how much you sold the asset for (subtracting any expenses incurred throughout the sale).

CGT is applicable to property, leases, shares, licenses, goodwill, contractual rights, foreign currency, and assets for personal use that were bought in excess of $10,000.

Assets that were purchased before 20 September 1985 such as a main residence, a vehicle, or depreciating assets utilised exclusively for taxable reasons are exempt from capital gains tax.

Nonetheless, if a main residence is built on more than two hectares of real estate, the homeowner will only be given a partial CGT exemption. This may also be potentially applicable to owners who have not lived in the main residence for the entire duration of ownership.

It is good to note that capital gains tax is not a stand-alone tax. It is a part of the income tax.

How much is it?

If an individual buys then sells their property within a year, the net capital gain will simply be included in the individual’s taxable income after offsetting the individual’s other capital loss, if any. This will therefore raise the amount of income tax that should be paid.

On the other hand, if an individual owned the property for more than 12 months, working out the final taxable income will be slightly more complicated compared to just adding the net capital gain to the earned income.

Except if you are a company, which in that situation, there may not be any CGT discount (explained below). A company would just basically need to pay a 30 per cent tax on their capital gains.

Self-managed super funds meanwhile use a 33.3 per cent discount to their capital gain and pay for 15 per cent tax on the outstanding amount.

<h3?Working out the CGT for properties held for more than a year

There are two methods used to work out CGT for properties owned for more than 12 months prior to selling.

Capital gains tax discount method

Australian residents who have properties in their possession for more than 12 months may be eligible for a 50 per cent discount on their capital gain.

As an example, if a property owner sold a home an investment property that they’ve had in possession for more than 12 months for $150,000, then sold the property after 21 September 1999, they may only include $75,000 to their taxable income.

Indexation method

The indexation method may apply to Australian residents who have purchased property prior to 21 September 1999. It uses a multiplier to your initial layout called the ‘indexation factor’ to take inflation into account.

To work out the indexation factor, divide the consumer price index (CPI) during the time the property was sold by the CPI during the time when the property was purchased. Then, work out the indexation factor to three decimal places. For example, 1.2345 would become 1.235. The quarterly CPI can be found on ATO website and many other data source.

So let’s say an Australian resident invested in property for $200,000 on 1 January 1990. They then sold the property for $500,000 on 20 March 2018.

Presuming that they have paid off the deposit in the same quarter, the indexation factor can be worked out by dividing the CPI in the third quarter of 1999 as you are only permitted to index the elements of your cost base right up to 30 September 1999, by the CPI in the third first quarter of 1990. After rounding to three decimal places, the indexation factor will be 1.195 1.222 (68.7 / 57.5 56.2).

Next, to figure out the inflation-adjusted purchase price, multiply $200,000 by 1.195 1.222. The product of $239,000 244,400 would be the updated cost base.

As a result, the capital gain would be $500,000 – $239,000 244,400 = $261,000 255,600. This capital gain would then be added into the assessable income for the 2018 tax year.

Depending on eligibility, one may choose a method which results in the smallest possible capital gain. If you need reliable assistance and advice regarding capital gains tax, Click here to contact a Chan & Naylor Accountant today.


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