05 Oct A Comprehensive Guide to Capital Gains Tax on Investment Properties in Australia
Introduction to Capital Gains Tax
Capital Gains Tax (CGT) is a tax levied on the profit or loss you make when you sell or dispose of an asset, such as a rental property. It is not a standalone tax but forms part of your overall income tax liability.
How CGT is Calculated for Rental Properties
When you sell or dispose of a rental property, you either make a capital gain or incur a capital loss. The gain or loss is determined by the difference between the cost base of the property (the original purchase price, plus any improvements and associated costs) and the amount you receive upon its sale.
Calculating the Cost Base
The cost base of your property includes:
- Purchase price
- Incidental costs like legal fees, stamp duty, and real estate agent commissions
- Capital improvements made to the property
- The add-back of capital works deductions.
Full Example: Capital Gains on the Sale of a Co-Owned Rental Property
Karl and Louisa bought a residential rental property in November 2016 for a purchase price of $750,000. They incurred costs of purchase, including stamp duty and legal fees, of $30,000. After purchase, they improved the property by constructing a fence for $6,000.
Over the 7 years of ownership of the property, they claimed $5,000 in decline in value deductions and $35,000 in capital works deductions. (If they had purchased the property after 9 May 2017, then there would be no deductions for the decline in value of any second-hand depreciating assets.)
In June 2021, they entered into a contract to sell the property, and in November 2021 it was sold for $900,000. Their costs of sale, including legal fees, were $10,000.
The formula for the cost base is:
A + B + C + D − E – F = Cost base
Where:
A is the purchase price
B is the costs of the purchase
C is the cost of property improvements
D is the costs of sale
E is the capital works deductions
F is the total amount of decline in value deductions claimed over the period of ownership of the rental property
$750,000 + $30,000 + $6,000 + $10,000 − $35,000 − $5,000 = $756,000
The capital gains outcomes are:
Proceeds = $900,000
Proceeds − Cost base = Capital gain outcome
$900,000 − $756,000 = $144,000
As the property has been owned for more than a year, the discount capital gain rules reduce the capital gain to $72,000.
Karl and Louisa owned the property jointly. This means that they each have a capital gain of $36,000 which they will need to put in their tax return for the year in which the contract to sell the property was made, being the 2020–21 year.
Alternatively, you may want to consider this ATO calculator here.
Tax Implications
The CGT you’ll pay is dependent on your income tax rate for the year you sell the property. If you make a net capital gain, you’ll generally be liable for CGT. If you incur a net capital loss, you can carry it forward to offset against future capital gains. Once you have worked out your CGT implications you can use this calculator to work out how this would impact your personal tax implications.
Strategies to Minimise CGT
- Ownership Tenure: Holding the property for more than 12 months may make you eligible for a 50% CGT discount.
- Capital Loss Offsetting: If you have capital losses from other assets, you can use them to offset your capital gains.
- Main Residence Exemption: If the property was your main residence before renting it out, you might qualify for a partial or full main residence exemption.
- Inclusion of Capital Expenses: Costs incurred during the purchase, holding, and disposal of your property can be included in the ‘cost base,’ which can reduce your CGT liability.
- Timing: Consider the timing of the sale. If you expect to have a lower income in the following year, it might be beneficial to postpone the sale until then.
- Superannuation Contributions: Some Australians use a strategy called ‘re-contributing’ to their superannuation fund to reduce their overall tax liability, including capital gains tax. However, this is complex and should be done under professional advice.
Conclusion
Understanding the intricacies of Capital Gains Tax, especially when it comes to investment properties, can be complex. While this guide provides a comprehensive overview, it’s crucial to consult a tax professional or a financial adviser for personalised advice tailored to your specific circumstances.
Additional resources on this topic can be found on the ATO website here.
Next Steps
To find out more about how a financial adviser can help, speak to us to get you moving in the right direction.
Important information and disclaimer
The information provided in this document is general information only and does not constitute personal advice. It has been prepared without taking into account any of your individual objectives, financial solutions or needs. Before acting on this information you should consider its appropriateness, having regard to your own objectives, financial situation and needs. You should read the relevant Product Disclosure Statements and seek personal advice from a qualified financial adviser. From time to time we may send you informative updates and details of the range of services we can provide.
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