Profiting from property doesn't necessarily have to come with stinging capital gains taxes. Find out how you can avoid paying CGT
If you invest in property, capital gains tax (CGT) will raise its head when you're at your happiest - when you make a profit from the sale of a dwelling.
But there are a couple of ways to make healthy profits from real estate and avoid paying CGT. These include extending or renovating your home and then selling it (making use of the main residence exemption explained below), buying a property through your self managed super fund (SMSF), or renting out your home and then selling it.
If you don't know already, real estate is exempt from capital gains tax if purchased before 20 September 1985.
Avoid CGT if it's your main place of residence
You can avoid paying CGT if you sell a dwelling that's considered you 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.
Avoid CGT when renting out your main place of residence
If you have to move out of your home for whatever reason 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.
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 generally apply for partial exemptions in some circumstances.
You bought a property with the intention of renting it out, but later changed your mind and moved in. If you changed your mind and decided to live in the property you purchased rather than rent it, you'll be partially exempt from paying some 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.
Bills 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 the 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.
Avoid CGT by buying a property through your self-managed super fund (SMSF)
Buying a property through your SMSF is one way you can generate profits from residential real estate for when you retire and avoid paying CGT all in one hit. You use your super fund to purchase the home along with an SMSF property home loan to make up the total. This 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 and 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. If you can only afford to buy one property with your super fund then you'll have a lack of diversification. If you need to sell your property during your pension phase and the property market isn't performing, you may end up making small capital gains or in rare cases losing out.
Through doing your due diligence you can still invest in property and generate rental returns and capital gains without attracting huge taxes. By focusing on your main place of residency and the temporary absence rule as well as buying property through your SMSF, you can manage to dodge hefty CGT charges. Remember this is general advice, so always seek professional advice before undertaking any of these suggestions.
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.
The Property Tax Specialists are an award-winning leader in the Australian taxation field, with strengths in accounting, marketing and business. They can help with matters of asset protection, property investing, accounting and taxation, including capital gains tax enquiries. Fill out this form with your query to get into contact with an expert from Property Tax Specialists today.
Capital gains tax in a nutshell
- CGT is a tax which is added to your personal income for the financial year you dispose of an asset
- It applies to assets that were purchased on or after 20 September 1985. Any gain made on the sale of a CGT asset is included in your assessable income. The gain from the sale of a CGT asset can be reduced by 50% when you have held the asset for more than a year (in circumstances where the gain is not also income derived from carrying on a business).
- Your main residence is generally exempt from CGT, though this exemption is not available where the property is owned by a company or trust.
- CGT is charged on land that's next to or adjoining to your family home, if they're sold separately.
- CGT is charged on your family home if the owner stops being an Australian resident.
- CGT is charged when you sell your investment property.
- No CGT applies to deceased estates. This also applies if the property has been disposed of less than two years after the deceased died. If this is the case, the cost base is equal to the market value at the date of death if purchased before 20 September 1985. Otherwise, the cost base of the deceased person is used.
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.
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
What is capital gains tax?
Capital gains tax (CGT) is a tax paid on any profit you've made from the sale of an asset. A capital gain is the difference between what you paid for an asset and what you received when selling it. If you have lost money when selling an asset, you've made a capital loss.
In Australia the most common assets you may have to pay CGT on are:
- Real estate purchases
- Managed funds
There are also other circumstances which may be liable for CGT, such as:
- If an asset you own is lost or destroyed.
- If you stop being an Australian resident and you own assets.
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
Subtract your cost base from your property sale price and you have your capital gain or loss.
The sale price of your property minus the cost base gives you your capital gain or loss.
Once you've worked out the capital gain, the figure is then adjusted according to a number of variables, including:
- 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 individuals33.3% 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.
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.
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 ensure you're receiving the best rate, features and fees possible on your investment property.
Compare investor home loans
Rates last updated January 23rd, 2017.
- NAB Choice Package Fixed Rate Home Loan - 4 Years (Investor)
Comparative rate increases by 0.27% | Interest rate increases by 0.8%
January 16th, 2017
- NAB Tailored Fixed Rate Home Loan - 3 Years Fixed (Investor)
Comparative rate increases by 0.10% | Interest rate increases by 0.4%
January 16th, 2017
- NAB Tailored Fixed Rate Home Loan - 2 Years Fixed (Investor)
Comparative rate increases by 0.05% | Interest rate increases by 0.29%
January 16th, 2017
To get personal advice regarding your capital gains matter fill out the form above. This will put you into contact with an expert from Property Tax Specialists who can help you with property tax-related questions.
CGT on your life insurance payments
In 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.
We have a range of guides about investing in other asset classes or information for those considering purchasing more property.
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Frequently asked questions about Capital Gains Tax
How long do I need to live in a property before I can call it my main place of residence? What if I want to turn it into an investment later?
If a property is first established as a main place of residence, it will be exempt from CGT if sold at a profit at a later time. If the property is then rented out as an investment, the CGT exemption can continue for another six years - known as the six-year rule - but only if no other property is nominated as the main place of residence during this time.
Generally the property needs to be nominated as either a main residence or investment at the time of sale, as this is when capital gains is normally calculated.
When the ATO considers whether a property is established as a main residence, they’ll consider:
- Amount of time you live there - there is no minimum time you have to live in a property before it’s considered your main residence
- Whether or not your family resides there
- Whether you’ve moved your personal belongings into the home
- Your address on the electoral roll, among other things.
The longer a property is occupied with the above conditions, the more likely the ATO will consider it as your main residence.
My father has passed away and left two properties to me. Does capital gains tax (CGT) apply?
Q: My father has passed away and left two properties to me. The first property was his main residence, although it was rented out for a year prior to his passing. The second property was purchased in 1975 and rented out as an investment. I’ve decided to keep the residence and sell the investment property. Does capital gains tax (CGT) apply?
The first inherited property was the father’s principal place of residence so it will not incur either CGT or stamp duty once it’s sold or transferred. Given that the deceased didn’t nominate any other property as his principal place of residence while the property was being rented for the 12 month period, then there will be no CGT payable from the estate.
CGT also won’t apply to this property if it’s sold within 2 years of the death, irrespective of how the property is used during this timeframe. This also applies if the property is sold or transferred after it has been lived in by a surviving spouse or beneficiary under the will.
The second property is a pre-1985 asset so there is no CGT when the property is inherited. The cost base of the property will be adjusted to the current market value upon probate.
I've got a property which I want to subdivide - how does CGT work with subdivided properties?
When land is subdivided, a capital gains tax event only occurs when you go to sell one of the blocks. For working out your CGT liability when selling a block, the ATO states that the date you acquired the subdivided block is the date when you originally bought the land.
The cost base of the block is the original land's cost base "divided between the subdivided blocks on a reasonable basis".