What is capital gains tax?
When you sell capital assets, like real estate, cryptocurrency or shares, you can either make a capital gain or loss. This refers to the amount you receive by selling it, minus the amount you paid to acquire and maintain the asset.
You’re only obliged to pay CGT when you receive capital gains from the sale of assets that you acquired after September 20, 1985 (when CGT became effective). Your home (principal place of residence), car and belongings are exempt from CGT.
Capital gains or losses need to be declared on your annual income tax return. Gains are added to your assessable income and may increase the tax you need to pay. Losses can be used to reduce a capital gain.
How much is capital gains tax?
Residents in Australia are expected to pay capital gains tax on an investment property they sell. This is added to your assessable income for the year. For example, if your annual salary is $AUD70,000 and your capital gain is $AUD40,000, your total assessable income for the year is $AUD110,000.
Once you’ve determined your assessable income, compute your CGT based on your tax bracket for that year. Check the Australian Taxation Office (ATO) website for more information on resident tax rates. They also have a guide on rates for foreigners living in Australia.
If you end up in the highest tax bracket, you could pay up to 45% on your property’s gain. To make computing capital gains tax easier, use the ATO’s CGT calculator.
When do you pay capital gains tax?
CGT is paid as you file your tax return for the year you sell your property. For example, if you sell your property in September, you’ll be liable to pay CGT the following July, when the fiscal year ends.
Note that the date of sale refers to the date that you signed the contract to sell your property, not the date you chose to settle or move out.
How to avoid capital gains tax in Australia
1. Take advantage of being an owner-occupier
If you live in the property right after acquiring it, the asset can be listed as your Primary Place Of Residence (PPOR). That makes it exempt from CGT.
Note that you won’t be able to do this if you rented the property out and moved in at a later date. But you are entitled to a partial exemption proportionate to the “years lived in“ vs. “years rented.”
Example: You rent out a property for three years, then decide to move in and live there for six years. Then, you sell the property and gain $AUD100,000. Your taxable amount will be $AUD33,333, which is one-third of the amount you earned. In other words, you’re only taxed for the three years you rented out the house out of the nine years you owned it.
2. Wait for one year
Those who’ve owned a property for 12 months can receive a 50% tax discount on any gain they make on the property.
Example: You buy an investment property in 2015 and decide to sell it, making a capital gain of $AUD120,000. Because you’ve owned the property for more than a year, you can reduce the taxable amount by 50%, making it $AUD60,000.
3. Get the property reassessed before renting it out
Capital gain is calculated by the difference between the final sale price and the property value at the time it was rented. Hire a licensed valuer before renting it out, and they’ll provide you with a new cost base from which to calculate any future gains.
Example: You buy a house for $AUD150,000 and live in it for 10 years. After this period, you get the property revalued to $AUD450,000 then rent it out. Two years later, you sell the house for $AUD480,000.
This means you made a taxable capital gain of $AUD30,000. That’s a huge deduction compared to how much your taxable income would be if you had to deduct the gain from the property’s original price of $AUD150,000 before revaluation.
On the other hand, if you sold the property for $AUD420,000, you make a capital loss of $AUD30,000, because you sold the property at a lower price compared to its value before renting. You can offset this amount from a current or future capital gain. You can also use the loss to reduce a capital gain a year later.
It’s not possible to deduct capital losses or a net capital loss from other income.
4. Use an SMSF home loan
If you’re a member of a self-managed super fund, you can use it to purchase a house, together with a separate SMSF property home loan. Note that you’re not allowed to live in the home until you’re eligible to receive your pension.
Once you’re a retiree, you can sell the property you’ve bought with your SMSF without having to pay capital gains tax.
5. Use exemptions like the 6-year rule
If you rent out your property for six years or less, you can use this to gain a full capital gains tax exemption, as long as you’re not treating another property as your main residence.
While this is commonly called the “6-year rule,” it doesn’t refer to six calendar years. It only refers to the time your property has an active tenant. So, for example, you rented out a property for eight years, but it stayed vacant for several months that add up to two years, you’re still eligible for this exemption.
Example: You buy a house for $AUD500,000 and move in immediately, listing the property as your PPOR. After a year, you move overseas and get the property revalued at $AUD600,000. You return home after eight years and sell the house for $AUD900,000.
Your taxable gain is $AUD300,000 x 2/8 (you’re only liable for the two years out of the eight years it was rented because of the 6-year rule) = $AUD75,000. You can further reduce the capital gains tax from investment property by 50% because you’ve owned the property for more than 12 months. That lowers the taxable gain to $AUD37,500.
If you’re in the third tax bracket, your tax rate will be 37% (of the $AUD37,500 taxable gain). Hence, you made $AUD300,000, but your total CGT is $AUD13,875 for the two (out of eight) years you rented out the property.
The goal isn’t just to learn how to avoid capital gains tax when selling an investment property but to do it within the limits of the law. With the strategies on our list, you can significantly reduce your capital gains tax legally. Remember, you always have to pay your dues, but that doesn’t mean you have to pay more than what you should.