Capital gains taxes can hit you when you sell an investment property for a profit. Here's how to avoid or minimise CGT and exemptions you may qualify for.
Don't let CGT eat into your real estate profits. Learn the rules around capital gains tax and how full and partial exemptions can save you money.
What is capital gains tax?
Capital gains tax, or CGT, is a tax which is levied on the profits you make when you dispose of an asset. It applies to assets that were purchased on or after 20 September 1985. CGT is calculated by subtracting the cost involved in acquiring and holding an asset from the proceeds of the sale of the asset. Any gain made on the sale of a CGT asset is included in your assessable income in the financial year that you sell the asset.
For the sale of an asset where a contract is involved, such as property, CGT is assessed from the date of the contract, not the settlement. For a sale with no contract, CGT is assessed after you stop being the asset's owner.
When you're selling a home, any profit you make above the cost of acquiring and maintaining the home is considered a capital gain.
CGT on your life insurance paymentsIn addition to property, some Australians will need to pay CGT on life insurance payments. This is because a life insurance policy is a 'choose-in-action' policy, meaning it's an agreement made with the insurance company to pay out an amount of money at an agreed time (the policy owner's death). It's important to note that, like property, life insurance also has a range of exemptions on offer.
Find out more about CGT exemptions and review your life insurance policy today
How much CGT will I have to pay?
If you're selling an investment property, the CGT calculation is based on the sale price of a property minus your expenses. These expenses are called your cost base. The cost base is the total sum of the original purchase price, plus any incidentals, ownership and title costs minus any government grants and depreciable items. Depreciable building items were not included in the cost base calculations prior to 1997.
- Incidental costs - stamp duty, legal fees, agent fees and advertising and marketing fees.
- Ownership costs - rates, land tax, maintenance and interest on your home loan. Note that you can only add rates, land tax, insurance and interest on borrowed money to your cost base if you acquired the property after 20 August 1991, or didn't use the property to produce an assessable income e.g vacant land or main residences.
- Improvement costs - replacing kitchens, bathrooms or any other improvements you've made on the property
- Title costs - legal fees associated with organising and defending your title on the property
How is Capital Gains Tax calculated?
Calculating capital gains tax is relatively simple:
- Step 1: Calculate your cost base
Purchase price + All costs - FHOG & claimed depreciation = Cost base
- Step 2: Subtract cost base from your property's sale price
Sale price - cost base = Capital gain or loss
- Any percentage of time when you owned the property that it was rented out and not your main place of residence.
- If you've held the property for longer than 12 months and therefore are eligible to receive a 50% discount.
There are three methods of calculating capital gains tax:
|Method||Description||How to calculate|
This calculation method is for those who have held an asset for less than 12 months.
|This is the most basic method of CGT calculations.||Take the cost base away from the sale price.|
This method is for those holding assets for more than 12 months.
|Those using this method are entitled to a 50% discount off of the CGT liability for individuals or a 33.3% discount off of the CGT liability for super funds||Take the cost base away from capital proceeds and deduct capital losses. Then take your discounted percentage and reduce the amount by it.|
If you bought the asset before 11.45am (ACT time) 21 September 1999 AND own the property for more than 12 months.
|You can increase the cost base by applying an indexation factor based on the Consumer Price Index (CPI) up to September 1999.||For more information on this calculation method visit the ATO website.|
*Based on information from the ATO.
Once these factors are worked out you'll be left with the amount of capital gains that will be included in your taxable income and taxed at your marginal rate. There are ways to avoid capital gains tax, though, whether fully or partially.
Full CGT exemptions
Some situations can see you avoid capital gains tax entirely. Depending on your circumstances, you may be eligible for a full exemption.
Time of purchase
Property is exempt from capital gains tax if purchased before 20 September 1985.
Main place of residence
You can avoid paying CGT if you sell a dwelling that's considered your main place of residence. You can only ever have one main residence at any given time unless you're selling your old main residence and buying another. In this case you're entitled to an overlap period of six months as long as the new property will be your new main residence, you lived in the old property for at least three continuous months in the 12 months before you sold it and it wasn't used to produce rent in this same 12 month period. The ATO doesn't give an exact description of what constitutes a main residence, but gives the following points to consider:
- You and your family live in the dwelling.
- Your mail is delivered there.
- You have your personal belongings there.
- You're registered to vote at the property's address.
- You have connected a phone, gas and electricity to the property.
If you've lived in your home for the whole time you've owned it, haven't rented it out either completely or to a lodger and the land is smaller than two hectares, you'll get a full exemption on CGT when you sell. This is helpful if you plan to live the renovator's life: selling your home, moving into another, renovating it and then selling the renovated property. And while you won't make a rental income if you go down this path, all profits made from the renovation are exempt from CGT.
If you have to move out of your home and choose to rent it out, you may be exempt from some CGT liability under the 'Temporary Absence Rule'.
What is the rule? If you move out of your home and rent it out, under the law, the property is still treated as your principal residence for a period of up to six years. If you sell the property within this time from you will be exempt from paying CGT if you profit from the sale. You are also exempt from paying capital gains on the income generated from the leasing of the property.
What's the catch? You will still need to pay CGT on the sale of one of your dwellings.
If you're moving out of your home and renting it out, you're going to need somewhere else to live. You will need to elect one of the two dwellings as your principle place of residence and a tax will be applied to the sale of your non-primary property.
Buying a property through your SMSF is one way you can generate profits from residential real estate and avoid paying CGT. You use your super fund to purchase the home along with an SMSF property home loan to make up the total. The loan is then paid off through your super contributions.
If you sell the property once you've retired, you'll pay no capital gains on the property. Even if you sell the property while you're still accumulating your super, this will be taxed at a rate of only 15%. Holding onto the property for longer than a year will effectively drop this rate to 10%.
Buying a property with your SMSF comes with some risks, so you should never attempt it without first seeking professional advice.
Partial CGT exemptions
While avoiding CGT liability altogether may not be possible if you haven't lived in the property before you rented it out, you can still apply for partial exemptions in some circumstances.
Making an investment property your main residence
If you changed your mind and decided to live in a property you purchased as an investment, you'll be partially exempt from capital gains tax. In this case, the CGT you'll owe will be worked out by comparing the number of days you lived in the property to the number of days you rented the property.
Bill's capital gains tax issue
Bill buys a property and rents it out for two years, but later decides to move into it and lives in it for six years. He then sells it, making a capital gain of $400,000.
He only has to pay CGT on a quarter of that amount, which works out to be two years out of the eight which are not eligible for an exemption.
This means Bill would add $100,000 to his taxable income because of the CGT. He's also held onto the property for longer than 12 months, so after taking into account the 50% discount he's entitled to because of this, he would be able to get away with an increase to his taxable income of just $50,000.
Using your main residence as a business
If your main residence is being used to generate income, the CGT exemption is reduced accordingly. The Australia Tax Office has clear differences between the two following types of businesses: a 'place of business' or a 'place of convenience'. Different rules may apply according to how you use your main residence, so it's best to consult your accountant to see which situation applies to you.
If you are over 55 and sell a small business property, there may be a $500,000 portion that is exempted from CGT. A sale of small business when used for supporting retirement is also exempt.
What can I deduct if I'm using my main residence as a business?
It's important to consider the additional cost of CGT that could apply on the business portion of your home. This could be applied to the sale of your main residence in the future.
Maintenance costs (allowable for both a place of business and a place of convenience)
- Utility bills
- Depreciation of office furniture and assets
Ownership costs (only allowed for a place of business)
- Rent and mortgage repayments
- Interest charged on the loan
- Insurance premiums
Holding an asset for more than 12 months
While this isn't technically an exemption, if you buy an investment property and hold it for more than 12 month, you're entitled to a 50% discount on the amount of CGT payable. The discount is 33.3% for super funds.
Investing in affordable housing
From 1 January 2018, investors who invest in qualifying affordable housing will receive an additional 10% discount, bringing their CGT discount to 50%. To qualify, the investment property must be provided below market rent and made available for tenants on low to moderate incomes. It must also be managed by a registered community housing providers, and the property must be held as affordable housing for a minimum of three years.
What if I've made a loss?
A capital loss is when you've sold the asset for less than your 'reduced' cost base. A reduced cost base is the same as a normal cost base, although it also includes any balancing adjustments such as improvements to the property.
You can offset any capital losses you've made for the year against any capital gains you've made and this will reduce the amount of capital gains that'll be included in your taxable income. However, you can't deduct capital losses from taxable income. You can also carry any capital losses forward in future years and offset these against capital gains you've made.
Get professional advice about your capital gains tax issue
Capital gains tax is a complex area of Australian taxation law, so sometimes you might need an expert to help you deal with these matters. By filling in the form below you can speak to a specialist from Property Tax Specialists about issues relating to your capital gains question.
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Other tax tips: negative gearing benefits
Even if you can't improve or reduce your CGT bill, there are other tax savings you could be making. A low rate home loan can sometimes turn your investment property from a cashflow negative to cashflow positive property while still seeing you receive negative gearing benefits.
You can also compare some home loans below to see what rates, features and fees are possible with an investment property.