By Donie Collins, Director of DMC Property Advisory

Paying Capital Gains Tax (CGT) isn’t necessarily a bad thing because it means that you have sold an asset and made a profit, which is better than a loss, of course.

Capital Gains Tax basics

The amount of tax you must pay on any capital gain is calculated using the below formula (for any asset purchase after 20 September 1985).

(A) Net sale proceeds – this includes the amount that you received less any direct selling costs such as advertising expenses, agent fees, legal fees, brokerage, and so forth. If you have gifted the asset or sold it to a related party for less than market value, then your net sale proceeds are deemed to be equal to its market value.

(B) Cost Base – this includes the total cost of the asset, which is what you originally paid for it plus any related costs such as brokerage for shares, stamp duty and buyers’ agent fees for property, legal fees, professional fees, and so forth. You may be able to include any holding costs and capital improvements in your cost base if you haven’t already claimed a tax deduction for them. The cost base will be reduced by any depreciation or amortisation claimed on the asset during the ownership period.

(C) 50% discount – if you have owned the asset for more than 12 months and you are a resident for Australian Tax purposes, you are entitled to reduce the net capital gain by 50%.

(D) Marginal Tax Rate – The final step is to multiple the discounted capital gain by your marginal tax rate.

What if you make a capital loss?

A capital loss occurs when your net sale proceeds are less than your cost base. Capital losses can be used to offset capital gains. However, capital losses cannot be used to offset other income (such as employment income).

Instead, you may carry a capital loss forward to use it in future years if/when you make a capital gain.

Main residence exemption

You are permitted to claim a CGT exemption on your home if (1) you and/or your spouse live in it, (2) you have not used it to generate an income e.g. rented it out, and (3) the land is 2 hectares (2,000 sqm) or less.

Your spouse and you can only nominate one main residence at any one time.

Therefore, if you have two homes (e.g. a city residence and a beach-side property), only one of those properties can be deemed as your main residence. Various rules apply for different situations such as your main residence being on multiple titles e.g. adjoining vacant land, you having multiple dwellings on the same title, or you subdivided your main residence.

In these circumstances, it is very important to obtain professional advice from a holistic accountant.

Converting the main residence into an investment property

If you rent out a former main residence, you may only receive a partial main residence exemption:

1. If you occupied the property immediately after you purchased it, your cost base will be deemed to be equal to the market value on the day that it first became available for rent; or

2. If you initially rented the property to a tenant and occupied it thereafter, your main residence exemption will be pro-rata by the number of days that you occupied the property. For example, if you purchased a property and rented it out for 2 years, then occupied it for 5 years, and then rented it out again for 3 years before selling it, then 50% of the gross gain can be disregarded under the main residence exemption (as you occupied the property for 5 out of the total 10 years you owned it).

If you rent out a former home and don’t claim another property as a main residence, you can continue to claim the main residence exemption for up to 6 years.

This is called the-6-year-rule.

If you re-occupy the property prior to the end of the 6-year period, it is possible to reset this exemption for another 6 years. If you do not re-occupy or sell the property before the 6 years has expired, you will lose this exemption.

A company is not entitled to use the 50% discount.

Discretionary Family Trust

If a family (discretionary) trust crystalises a capital gain, it can distribute that gain to various individuals and/or entities. Because trust distributions retain their tax nature and attributes, the capital gain will be taxed according to the beneficiary’s tax position.

For example, if it is distributed to individuals, they will be entitled to the 50% discount, are able to offset capital losses, and so forth. If it is distributed to a company, it will not benefit from the 50% discount. Essentially, the capital gain flows through to the beneficiaries.

Super funds are concessionally taxed.

In the accumulation phase (i.e. pre-retirement) a super fund is taxed at a flat rate of 15%.

A super fund can apply a CGT discount of one-third if it has held an asset for more than 12 months. As such, the effective rate of tax on capital gains is only 10%. In retirement (pension phase), the rate of tax is nil on all income and capital gains.

Inherited assets

When you inherit assets, you inherit their original cost base and nature of the asset. This means if you subsequently sell the asset, you will be taxed on the full gain i.e. based on the predecessor’s cost base. Inheriting assets that have been held for many decades, tax records can be difficult to obtain which can be challenging.

If you are selling the predecessor’s former home, you may be able to utilise the main residence exemption. If the predecessor purchased the asset before 20 September 1985 (i.e. pre-CGT), then your cost base is deemed to be the market value as at the date of death.

Donie Collins

DMC Property Advisory

0405 958 597

dcollins@dmcproperty.com.au

www.dmcproperty.com.au