What is capital gains tax?
When you're selling real estate, you usually stand make a profit – 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 and units, cryptocurrency, collectables and personal-use assets, when you dispose of them. 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!
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.
If you've bought and sold a property within a 12-month period, your capital gain is simply added to your income – easy. But if you've owned your property for longer than 12 months before selling, there are some calculations to do.
There are two different methods used for figuring out how much CGT you need to pay – discount and indexation – and you can choose whichever method gives you the smaller capital gain (and therefore lesser CGT amount).
The discount method
This one's pretty simple. Once you've owned your home for 12 months, you automatically qualify for a 50 percent discount on your capital gain. This is known as the 12-month rule.
So let's say you bought a property for $200,000, lived there for 13 months, and then sold for $300,000, your capital gain is $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.
The indexation method
What's great about this method 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 calculators available on their website for figuring out how much CGT you need to pay.
How might the situation 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.
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 family live in it; your personal belongings are in it; it's the address your mail is delivered to; it's your address on the electoral roll; and services such as gas and power are connected.
You're eligible for a full CGT exemption if the house has been your home (as well as your partner and children/dependants) for the whole period you've owned it; you haven't run a business from it, rented it out or flipped it (ie. made money from the property), and it's on land of two or fewer hectares.
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 maintenance or work done on the home) – these costs incurred during the purchase or improvement of the property can usually 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!)
But how can you avoid capital gains tax when you sell a property that you've been renting out?
Live in it first.
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 your property for at at least 12 months before you can treat it as an investment property.
Some of the qualifying reasons to move out listed on the ATO website are accepting a new job interstate or overseas, staying with a sick relative long term, or going on an extended holiday.
If, at any time in the six-year period, you move back into the home, it resets this six-year rule – so you can move out again, rent it out and get yourself another six years. There's currently no limit on how many times a property owner can do this.
If moving in and out of a home every five-and-a-half years sounds like a hassle, but you want to evade CGT, you'll need to sell the home before that six-year marks hits.
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
No matter how you cut it, investment properties are liable for capital gains tax – and if you've bought a property with the intension of renting it out, without having lived in it first, you will have to pay CGT on profits you make when you sell.
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. If you live in the home while you carry out the renovations, you can treat it as your main residence and potentially avoid capital gains tax altogether.
If you're carrying on a business of flipping homes, however, the properties you buy are considered trading stock, and CGT doesn't apply to trading stock. As such, concessions such as the main residence exemption doesn't apply to income from the sale of the properties.
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.