We all know the old saying – the only certainties in life are death and taxes. But when it comes to selling your property, capital gains tax might just turn out to be one thing that you actually don’t have to bank on.
While this tax may apply to some property sales, it depends on factors including whether or not you live in the house and how long you have owned it. So, let’s go through the basics.
What is capital gains tax?
When you’re selling real estate, you’ll usually make a profit or what’s known as a “capital gain”. This amount is the difference between what it cost you to acquire (and maintain) the property and the amount you sell the property for.
Capital gains tax is the governmental tax you pay on these profits, and it doesn’t only apply to real estate. CGT can also apply to other assets, such as shares, cryptocurrency, collectables and precious metals. When it comes to property (and other sales involving a contract), CGT is assessed from the date of the contract of sale, not settlement.
CGT only applies to assets that were purchased on or after September 20, 1985, so if you bought your property before then, you don’t need to worry too much!
Do you pay capital gains tax on your home?
In most cases, you won’t pay capital gains tax on your own home if you have lived in it for the whole time you’ve owned it and you haven’t used it to make a profit. This condition means that if you have run a business from your home or rented it out for any period of time, you may need to pay capital gains tax when you sell it. If you have worked from home and claimed tax deductions for it, you may want to speak to an accountant or contact the ATO to find out what would apply for your situation.
The Australian Taxation Office (ATO) also notes that this exemption only applies if your property is 2 hectares or less in size and has a dwelling that you live in as your main residence (i.e. you live there most or all of the time).
How much capital gains tax do you have to pay?
As it counts towards your income tax, CGT isn’t a stand-alone amount, but rather a levy calculated based on the capital gain made from the sale of the home, which is then included in your assessable income in your tax return for that year.
A quick way to estimate your capital gains tax is to subtract the original cost of the property from the selling price. You can also factor in some expenses associated with the original costs, such as stamp duty and conveyancing fees.
But there is a bit more to consider beyond that.
The capital gains tax discount for Australian residents
If you’re an Australian resident and you’ve owned a property for at least 12 months, you qualify for a 50 percent discount on the capital gain.
As an example, if you bought a property for $600,000 and lived in it for 13 months, then sold it for $700,000, the total capital gains would be $100,000. But because you owned the home for more than 12 months, this brings that figure down by 50 percent, to $50,000.
This $50,000 is then added to your taxable income for the year.
Indexation for assets bought before 21 September 1999
What’s great about this calculation is that it allows for inflation – but it only applies to assets you bought before September 21, 1999. To use this method for figuring out CGT, you apply the relevant indexation factor, which is worked out using the Consumer Price Index (CPI) at the time of acquisition and sale. You can only index for costs associated with the time period before that September 1999 cut-off.
The Australian Taxation Office (ATO) has detailed information and a calculator you can use to find out how much CGT you may pay. Alternatively, you could speak to a tax agent.
How might CGT change for different types of real estate?
How many years you have to wait to legally get around or minimise capital gains tax will depend on how you’ve used your property since taking ownership.
House flippers will find themselves working within a different framework to those selling an investment property, as will first-home buyers selling a house they’ve been living in, for example – and there are also differences for people selling large areas of farmland greater than two hectares.
Primary residence
If you want to know how to avoid capital gains tax on your primary residence, it’s fairly straightforward. Your main residence is usually exempt from capital gains tax, so the profit when selling is all yours.
According to the ATO, a property is considered your place of primary residence (POPR), if:
- You and your immediate family have lived in it for the whole period you have owned it.
- It has not been used to produce income.
- It is on no more than 2 hectares of land.
So, if you meet these conditions, you’ll be eligible for a full CGT exemption.
Investment property
If you buy a home with the sole purpose of renting it out, you’ll be subject to CGT when you sell. But there are ways you can reduce the amount of capital gains tax you have to pay.
Firstly, there’s the 12-month rule we mentioned earlier. Once you’ve held a property in your name for a full 12 months (excluding the date of acquisition and subsequent sale), you’re automatically entitled to a 50 percent tax discount on any capital gain you make when selling.
Secondly, be sure to keep all records of and receipts for any outgoing expenses (such as stamp duty, real estate fees, renovations) – eligible costs incurred during the purchase or improvement of the property can be added to your cost base. And the higher your cost base, the lower your capital gain will be – but you must be able to show this (hence, keeping those receipts!)
Another factor to consider is whether you have claimed deductions for the property on your tax returns, such as decline in value or capital works deductions. If you have, these will need to be subtracted from your CGT calculations.
A house you initially lived in but now rent out
If you want to leave the home you’ve been living in (aka you PPOR) and rent it out, you can continue to treat it as your main residence for tax purposes for up to six years (if you don’t rent it out/produce income from the property, you can continue to regard it as your main residence for tax reasons indefinitely).
Note: You do have to live in the property as your main residence first before you can rent it out and be eligible for an exemption.
If, at any time in the six-year period, you move back into the home, it resets this six-year rule. So in theory, you can move out again, rent it out and get yourself another six years.
Keep in mind that if you claim a dwelling as your main residence – even if you’re renting it out – you can’t use another property as your PPOR at the same time (outside of a six-month window if you’re moving house). So while you can still buy another property to live in, there’s no ‘main residence’ exemption and the second property will be subject to CGT.
A house you initially rented out but now live in
If you bought a property with the intention of renting it out, without having lived in it first, you will have to pay CGT on profits you make when you sell it.
If you move into the property after having rented it out and it becomes your main residence, you’ll pay CGT on the profits from the time period it was rented out. However, you may be able to receive a CGT exemption on the period that the home was your property of residence, and having owner the home for more than 12 months, you should be entitled to the standard 50 percent reduction.
A house you flipped
If you “flip” a house (that is, renovate to increase its value and then sell to make a profit), again, the 12-month rule can get you at least a 50 percent reduction on CGT. But typically any intention to flip a house for profit is likely to be liable for CGT. If that’s your plan, it’s a good idea to speak to a tax agent or licensed financial advisor to decide on the most cost-effective approach.
A block you sub-divided
If you’re looking to sell part or all of a block you’ve subdivided and built on, each of the blocks is registered with a separate title and is subject to the same CGT rules as any other properties. So if you bought land, subdivided, and then built and lived in a home on one of those blocks, you could qualify for the 50 percent deduction and, if it’s your main residence, potentially avoid CGT altogether when selling.
All of this advice is intended as general information; the best thing you can do to understand your own personal situation when it comes to capital gains tax and minimising it legally is to speak with an accountant or solicitor.
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