Capital gains tax is something most Australians have heard of, at least in passing. However, like many financial concepts, it tends to be surrounded by a great deal of confusion and misconception.
If you intend to purchase (or have already purchased) and sell a property, it’s inevitable that you will have to deal with capital gains tax on some level – even if it’s just working out whether or not you’re liable. By familiarising yourself now, you can help prepare yourself for when it comes time to sell.
Read on for our ultimate guide to the CGT, including how to calculate capital gains tax, how to avoid or minimise the amount you pay and more.
Capital gain is the difference between how much you paid for an asset and how much you received when you sold it (minus the costs incurred in selling it).
Introduced in Australia in 1985, the CGT means you have to pay a levy on that capital gain in the year you dispose of the asset. A capital gain tax can apply to shares, contractual rights, licences and even personal collectables above a certain value, but you’ll most often hear about it in the context of real estate.
For example, you buy a three-bedroom investment property in October 1999 for $194,000. In 2018, you sell this property for $770,000. Your purchasing costs in 1999 were $2,500. Over the years of ownership, costs were $168,820, and the sale costs $30,500. Therefore, the difference between the purchase and sale price, less cost, is $374,180.
Thankfully, that’s not to say you would be required to pay $374,180 in capital gains tax in a lump sum. In the following section, we’ll explain how to calculate capital gains tax relative to your personal situation.
|Total Ownership Costs||$201,820|
|Capital Gain (Net Gain – Ownership Costs)||$374,180|
While other countries, like the US and UK, also have a capital gains tax, these are calculated in different ways. It’s crucial to ensure you reference the correct information when determining how capital gains tax is calculated on property in Australia.
The first step towards calculating your capital gains tax is always determining your cost base. This is the amount you paid for the asset, as well as costs incurred in buying and selling it and incidental expenses, which may include:
Otherwise known as capital cost, these may include:
Once you have your cost base, there are two methods you can use to calculate your capital gains tax – the discount and indexation methods. In most scenarios, you can choose to use the strategy that leads to the lowest capital gains tax.
You know how your parents used to say, “back in my day, that would have only cost me a sixpence!”? Well, the indexation method is based on similar logic.
It’s calculated by dividing the consumer price index (CPI) at the time you sold your property by the CPI at the time you bought the property, rounded to three decimal places. You would then add that number to your initial cost price to get your inflation-adjusted purchase price, then subtract that amount from your sale price. You can find a table of Australia’s historical CPI rates here.
|Less than 12-months|
|Property ownership is less than 12-months from the date of purchase.||The most basic method of Capital Gains Tax (CGT)||Sale price less cost.|
|Property ownership is greater than 12-months from the date of property purchase ownership costs.||A 50% discount applies to property purchased after September 21, 1999, for individuals and 33.3% for super funds.||The purchase price + sales price = net gain – any ownership costs.|
|Property ownership began after September 20, 1985, but before 11.45am (ACT time) September 21, 1999.||The cost base increases by applying an indexation factor based on Consumer Price Index (CPI).||marginal tax rate x indexation factor x capital gain.|
One major misconception about the CGT is that it’s a separate tax to the one you pay at the time of your annual tax return. However, it’s simply added to your taxable income in the year you sold or disposed of the property, and paid as part of your income tax assessment.
The capital gains tax is ‘triggered’ by a CGT event. Generally, this occurs when you sell an asset, but it can also occur if it’s given away, destroyed or if you cease being an Australian resident.
There are a few strategies you can use to eliminate or minimise the capital gains tax you pay on a property.
If you live in your property for at least six months once you purchase it, you may be exempt from the capital gains tax. However, in this circumstance, you must be able to prove it’s your primary place of residence. The criteria used to determine whether a property is your main residence include:
There is also a tax break known as the six-year rule. This states that if you purchased the property to live in and had to move for reasons like a job or extended holiday, you can also become exempt from the CGT while leasing it out.
However, this exemption can only be claimed if no other property is nominated as your main residence. Interestingly, if you eventually move into the same property, the six-year exemption resets.
Under the main residence exemption, you’re generally not required to pay capital gains tax if you sell the home you live in.
The current tax-free threshold for Australian residents is $18,200. So, in the highly unlikely scenario that an individual’s income only comes to $18,200 after selling a house on top of their salary, they would be exempt from the capital gains tax.
You only pay the capital gains tax once per property sold, in the year you disposed of it. However, if you were to purchase and sell another property, you would be required to pay capital gains tax on that transaction, too.
Whether or not you’ve owned your property short or long term will determine the method you need to use to calculate your capital gains tax.
If you purchased the property before 21 September 1999 and have held it for at least 12 months, you would usually choose the indexation method of calculating your capital gains tax.
If you sell your property within 12 months of acquiring it, you will pay full capital gain. However, if you’ve held it for over 12 months, you would be eligible for the discount method of calculating capital gain tax.
Vacant land and farms are also subject to the capital gains tax. Like real estate properties, how much tax you pay will be determined by your profit from the sale and how long you’ve owned it. It’s also worth noting if you live on a property but it’s larger than two hectares of land or it’s been used to rent or run a business, you cannot claim the CGT exemption. You also cannot claim the six-year rule on vacant lots.
Each time you sell an investment property, you will almost always pay capital gains tax on the transaction. Like any rental property, you can use either the indexation or discount method to calculate how much taxable gains tax you owe.
However, calculating your capital gains profit on investment properties can differ from rental properties. You will need to add your purchase price to expenses including stamp duty, fees for tax advice and title cost. Then, you will need to deduct the costs of the building depreciation that you’ve claimed over the years as well as any capital costs.
This includes expenses like:
You would then calculate the difference between your cost base and your capital proceeds. The figure you are left with is the basis from which you would determine your capital gains tax.
When you inherit a property, any capital gain is usually disregarded when it changes hands. However, this only applies if the property is passing to the deceased person’s executor, beneficiary (the next of kin or the person named in the will), or if the property is passing from the deceased person’s legal representative to the beneficiary.
If the property is passing to a foreign resident or a tax entitled entity (like a charity) the capital gains exemption no longer applies.
Although capital gains tax generally doesn’t apply when you inherit property, you will have to pay it if you sell or dispose of the property – unless the property is exempt.
When it comes to capital gains tax, there are special rules that apply to inherited dwellings. Though in some cases you will have to pay, in other cases you may be fully or partially exempt.
Whether or not you’re exempt will depend on:
If not exempt, you’re liable to capital gains tax and you will need to know the cost base of the asset. This might be the value of the asset when the deceased acquired it or the value of the property when they died, depending on the circumstances.
Since 2019, the only update to government capital gains tax policy concerns foreign residents.
On 12 December 2019, the government passed a law that would mean the capital gains tax main residence exemption is no longer available to foreign and temporary tax residents. This includes Australian citizens and permanent residents who are non-residents for tax purposes.
Previously, foreign residents were able to claim the capital gains tax primary residence exemption in the same way most Australian tax residents can for their main residence.
Special circumstances for capital gains tax exemption as a foreign resident:
Since 1 July 2020, foreign residents are no longer entitled to a capital gains tax exemption unless they satisfy one of the following events. The event must occur within 6 years of the individual becoming a foreign resident.
By using this handy guide, you can learn how to calculate capital gains tax on your property, as well as minimise or eliminate the amount you pay. However, it’s important to always consult a tax professional when preparing your tax assessment, especially when it comes to your CGT.
Updated by Kathryn Lee December 2020
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