Everything you need to know about CGT on property investment

What is capital gains tax on property?

A capital gain is the profit you get from the sale of an asset, like an investment property. 

Capital gains tax - or CGT - is a government tax on this profit (gain). It is calculated by subtracting the cost involved in owning your property from the proceeds of the sale. You can also make a capital loss, when you sell your investment property for less than you initially paid for it.

Capital gains tax applies to any asset that was purchased on or after 20 September 1985, the date this tax came into effect. You are only liable to pay capital gains tax on a property that is not your primary residence. Any profit you make from the sale of an investment property is part of your annual income tax assessment, and is added to your taxable income in the year you sold the property.

Let’s now understand how you go about calculating your capital gain. 

Calculating your capital gain, with a real-world example

The easiest way to work out the capital gain is to take the selling price of your investment property and subtract the original cost and certain expenses you incurred when buying, holding and selling your investment property, such as rates, land taxes, renovation expenses, repair costs, insurance premiums, etc. The remaining amount is your total capital gain or loss.

Example: You purchase an investment property for $500,000, and you incurred costs of $18,500 when you acquired, held and eventually disposed of the asset. If you end up selling the property later for $700,000. The capital gain would be $181,500.

Keep detailed records of all expenses related to your investment property. This will make it easier for you to work out if you made a capital gain or loss in a tax year. 

Now let’s look at how you work out your capital gains tax.

How is capital gains tax calculated?

The amount of capital gains tax you pay depends on two factors, your marginal tax rate and the amount of gain or profit you earned from the sale of your investment property.

Capital gains tax is not taxed separately in Australia, so there is no specific rate of tax applied. Instead the gain - or profit - is added to your overall income for the tax year, so your final tax rate will depend on your personal marginal tax rate.

Many property investors choose to get advice or help from a professional, like a tax accountant - as the rules around CGT can be complex.  With this in mind, here are three methods for working out your capital gain. To maximise your ROI, and the amount of tax you pay, you should choose the method that gives you the smallest capital gain.

Indexation method

This method is for any assets purchased prior to 21 September 1999, and which you have held for 12 months or longer. The calculation is based on an indexation factor that uses the consumer price index (CPI) for the period up to that date.

Capital gains tax discount method

If you hold any capital gains tax asset for longer than 12 months you will get a 50 per cent discount on your capital gain. Note: If you sell your investment property within 12 months of purchase, you will pay tax on the full capital gain.

Other method

If you have held your investment property for less than 12 months, then you can simply subtract all your expenses associated with holding it from the cost of purchase. 

Let’s now look at strategies to legitimately avoid or minimise how much capital gains tax you pay.

How to avoid capital gains tax in Australia?

As an investor there are a number of ways you can minimise the capital gains tax you pay. These can be divided into full exemptions - where you avoid paying any capital gains tax; and partial exemptions - where you avoid paying some capital gains tax.

Full capital gains tax exemptions

The following are scenarios where you will avoid paying any capital gains tax:

• Time of purchase: if you purchased your investment property before 20 September 1985, you are exempt from paying any capital gains tax on it. 
  
• Primary residence: there is no capital gains tax on your primary place of residence, which the Australian Tax Office (ATO) classifies as where you are registered to vote, receive all your mail and have utilities connected.
  
• SMSF investment: if you are a member of a self-managed super fund, you can purchase an investment property through it, potentially using a SMSF home loan. This allows you to avoid paying capital gains tax, provided you sell it when you are in the retirement phase.
  
• The 6-year rule: if you are not treating another property as your primary residence, you can rent out your investment property for six years or less, and get a full capital gains tax exemption. The six year timeframe applies to the period it was actually occupied by tenants.

Partial capital gains tax exemptions

The following are scenarios where you will pay some capital gains tax:

• Own the property for more than a year: if you hold your investment property for more than 12 months you receive a 50% discount on the amount of capital gains tax payable. This discount is 33.3% for a SMSF.
  
• Using the main residence as a business: if you run a business from your primary residence you are able to claim a capital gains tax exemption for a portion of this. A tax accountant can help you work out how much this is.
  
• Making an investment property your main residence: if you start to live in your investment property you can claim a partial exemption from capital gains tax, which is calculated for the portion of time when it was a rental property.
  
• Invest in affordable housing: from 1 January 2018 if you invest in a property and offer it for rent to tenants with low incomes and charge below market rates, you qualify for a further 10 per cent discount on capital gains tax. 
  

What happens if you make a loss from the sale of your rental property?

What if I've made a capital loss?

If you have made a loss from the sale of your investment property, you can use it to reduce the tax from other capital gains. The ATO also allows you to carry forward net capital losses forward indefinitely, so you can claim these in a future tax year - They don’t allow you to deduct capital losses from your taxable income. 

When calculating your capital loss, you need to use the property’s “reduced” cost base. To find this, you simply adjust the normal cost base for any balancing adjustments (e.g. improvements you’ve made to the property)

As you can see capital gains tax is a complex area of Australian taxation law, so we recommend getting a tax specialist to help you. They can help you minimise the amount of CGT you pay, which helps to maximise the ROI from your investment.

Have any questions about CGT - or anything else? We’re happy to help, and our local team are available to chat at a time that suits your schedule.