Capital gains tax is an integral part of your overall income tax obligations. Disposing of an asset – that is, you stop being the owner – can trigger an event where you may need to pay this tax, depending on whether you made a capital gain or a capital loss.
It can get confusing, especially when it comes to the operating rules and procedures (how it works, when to pay it, how to calculate it and potentially minimise it). So here’s a quick guide to help you breeze through this part come tax time.
What is capital gains tax?
Capital gains tax is the tax levied on profits from the sale of assets such as shares and investment properties. As the name suggests, the tax only applies if you made a capital gain (profit) or if you sold an asset for more than you paid for it plus any incidental costs on the purchase and sale.
Suppose you bought an investment property for $300,000 (all fees included) and years later sold it for $500,000, CGT will apply to the $200,000 capital gain.
Essentially, you pay a tax on the sale proceeds you make from an investment.
Investments most commonly subject to capital gains tax include shares and properties used to produce income (either through rent or capital appreciation). CGT can also apply to trusts, contractual rights, and business goodwill.
If you think investing outside of Australia will keep your profits from the taxman’s scrutiny, you couldn’t be more wrong. Here’s the thing: The location is irrelevant when it comes to capital gains tax as it applies to the sale of assets you’ve owned whether they are in Australia or overseas. That includes your Swiss Alps chalet or shares in Apple (AAPL).
So make sure you report all capital gains you made to the Australian Tax Office (ATO) after the end of the financial year every 30th of June lest you want to face potential penalties.
How is Capital Gain Tax calculated?
CGT forms part of your income tax. This means, your capital gains are integrated into your assessable income in the financial year the gains happened and are taxed at the marginal rate under which bracket you fall.
For example, if your taxable income is $44,000 and you realised a $5,000 capital gain in the same year, your taxable income would be $49,000, which would put you in the 32.5-cent bracket ($45,001 - $120,000) instead of the 19-cent bracket ($18,201 - $45,000), applicable until the end of 2023-24 financial year.
Beginning FY 2024-25, a taxable income totalling $49,000 will be taxed at 30 cents to the dollar.
Using InfoChoice’s income tax calculator, the tax you will pay for the figure comes to $7,372 (FY 2023-24).
Capital Gains Tax discount explained
Any capital gains you (as an Australian individual) make from the sale of an asset you held for over 12 months are eligible for the 50% discount. The CGT discount method primarily aims to encourage long-term investment and partly to compensate for the effects of inflation over the holding period.
Note that the 12-month ownership requirement excludes the day of acquisition and the day the CGT event was triggered.
Now, if you do meet the ownership requirement, you are eligible to only report half of your net capital gains on your taxable income. To understand how it works, let’s look at our imagined property investor’s transaction using the discount method and the steps above.
Dixon bought an investment property in January 2021 for $600,000 and paid $25,000 in stamp duty and other fees. He also racked up an additional $10,000 in ownership costs. He then sold the property in January 2023 for $750,000 and paid another $10,000 in fees and commission.
Adding the purchase price and the incidental costs Dixon picked up for owning the asset brings his cost base to $645,000. Subtracting this figure from his sale proceeds leaves him with a gross capital gain of $105,000.
Since Dixon held the asset for two years before selling it, only $52,500 of his capital gain will be added to his assessable income.
Calculating this can get tricky if you bought or sold multiple lots of the same stock, for example, in a year, but your share trading platform or accountant should be able to calculate this for you.
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | LVR | Lump Sum Repayment | Additional Repayments | Split Loan Option | Tags | Features | Link | Compare |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
6.29% p.a. | 6.20% p.a. | $2,473 | Principal & Interest | Variable | $0 | $0 | 80% | Featured APPLY IN MINUTES |
| |||||||||
6.19% p.a. | 6.58% p.a. | $2,589 | Principal & Interest | Variable | $0 | $530 | 90% | Featured |
| |||||||||
6.29% p.a. | 6.34% p.a. | $2,473 | Principal & Interest | Variable | $0 | $600 | 80% | |||||||||||
6.29% p.a. | 6.29% p.a. | $2,473 | Principal & Interest | Variable | $0 | $0 | 90% | |||||||||||
6.39% p.a. | 6.41% p.a. | $2,499 | Principal & Interest | Variable | $0 | $250 | 80% |
What happens if you make a capital loss?
Not all investments turn a profit. If you sold a CGT asset for less than you paid for it, that means you made a capital loss.
However, all is not lost with capital loss as you can use this to lower your tax liability by offsetting your capital gains made in the same financial year. Say, you realised a capital gain of $50,000 and incurred a $20,000 capital loss, you can bring your taxable profit down to $30,000 at the outset.
But if your capital losses are greater than your capital gain, or if you incur a loss in a financial year where you don’t realise a profit, you can carry forward the losses and use them to offset gains in the following years. Capital losses can be carried forward indefinitely.
Another way you can turn a capital loss into a win is by using it to reduce capital gains not eligible for the CGT discount since you can choose which gains to subtract your losses from. CGT discount only applies to sold assets that were held for more than 12 months.
Important to note however that you cannot use capital losses to reduce the tax you pay on other types of assessable income other than capital gains. Deducting losses incurred from CGT-exempt assets such as your car is also not allowed.
When do you have to pay capital gains tax?
You need to pay your CGT in the relevant financial year that the capital gain happened. A capital gain or a capital loss happens during a ‘CGT event’.
A CGT event is the point at which you dispose of an asset that is subject to capital gains tax. Knowing when the CGT event is triggered is vital as the specific circumstances may affect the timing and calculation of your capital gain or loss.
Common asset disposals that trigger a CGT event include:
Sale of an asset
A CGT event is most commonly triggered upon the sale or disposal of an asset. If the sale of an asset involves a contract of sale, the CGT event is marked on the sale contract date and not the settlement date.
Let’s look at Laurie’s transaction for example. Laurie entered into a contract to sell a rental unit he owned on 25 June 2023. The contract was settled on 30 August 2023 and Laurie made a profit from the sale. He must then report his capital gain on his tax return for the financial year ending 30 June 2023.
However, if there is no contract, the CGT event happens on the date of sale.
For example, Shelley decided to sell off some of her shares without a share purchase agreement. The sale happened on 25 July 2023 so the CGT event was triggered on that date. Shelley must report any capital gain she made from the sale on her tax return for the 2024-25 financial year.
Loss or destruction of an asset
The CGT event happens when you first receive compensation for the loss, theft, or destruction of your asset. The capital gain is the difference between the amount of compensation and the asset’s original cost.
Suppose Flo owned a rental property damaged by floods in May 2023. She then received compensation from her insurance policy in September 2023. In this case, the CGT event happened in September 2023 and she must report any capital gain on her tax return for the financial year ending 30 June 2024.
But if no compensation is given, the CGT event is marked on the date the loss is discovered or when the destruction occurred.
Going back to Flo and her destroyed rental property. If she did not receive compensation for the damage, the CGT event happened in May 2023. She can use the loss she incurred to reduce her capital gains beginning FY 2023-24 onwards.
What assets are subject to capital gains tax?
Capital gains tax most notably applies to investment properties and shares. But CGT can also be levied on other assets used to generate capital gains.
According to the ATO, any capital gain or loss derived from the following assets must be reported on your tax return:
-
Real estate – Capital gains tax applies to investment properties including rental homes, vacant land, holiday houses, hobby farms, and business premises.
-
Shares and units – Profits generated from selling your shares of a company or receiving a distribution, other than dividends, from a managed fund are subject to capital gains tax.
-
Crypto assets – CGT applies when you dispose of crypto assets utilised to purchase items not for personal use.
-
Personal use assets – Capital gains derived from personal use assets like boats, furniture, and electrical goods that cost more than $10,000 are subject to CGT.
-
Collectables – Artwork, jewellery, antiques, coins and medallions, rare folios and manuscripts, and postage stamps or first-day covers acquired for more than $500 are subject to capital gains tax.
-
Intangible assets – Leases, goodwill, licences, and contractual rights may be subject to CGT.
-
Foreign currency – CGT applies to capital gains or losses you make on fluctuations in the foreign currency exchange rate.
What assets are exempt from capital gains tax?
Selling of assets you purchased before CGT was introduced on 20 September 1985 is automatically exempt from capital gains tax. However, the exemption doesn’t cover any major capital improvements you make such as property renovations.
Even if acquired after 20 September 1985, these assets are exempt from CGT:
Primary place of residence (PPOR)
The home that serves as your main residence is generally exempt from capital gains tax. However, this exemption will be lifted if you rent out a room to produce income, use any part of it to operate your business, or if it stands on more than two hectares of land.
A possible workaround for using your primary residence as investment property without attracting CGT is the ‘six-year CGT rule’. Under this rule, you can use your PPOR as a rental property for up to six years at a time as long as it’s considered your main residence.
The idea is so you are not financially burdened for having to move out for reasons such as a short-term work placement or caring for a relative in need.
After six years of absence (as in you stopped living in it), you can then move back in for a period, move back out, and restart the cycle. Although doing this can save you from paying hefty capital gains tax when it comes time to sell your property, rent earned will still be taxed as income.
Cars and motorcycles
Your car, which ATO defines as a motor vehicle that carries less than 1 tonne of load and fewer than nine passengers, is exempt from CGT.
Depreciating assets
Business equipment and items used in a rental property such as appliances and furniture are not subject to CGT. The decline in value of these assets can be claimed as income tax deductions, while the gains are treated as assessable income.
Granny flats
A granny flat arrangement created, varied, or terminated on 1 July 2021 onwards may be exempt from capital gains tax. For the CGT exemption to apply, the person with a granny flat interest must be at pension age or require assistance due to a disability and that the arrangement explicitly indicates the property is not used commercially (e.g. rent is collected).
How to calculate capital gains tax
Bring out the calculator, it's CGT time!
Establishing the date you acquired and disposed of an asset is important in working out your capital gains tax.
CGT applies to your net capital gain, which is your capital gain minus capital loss and any discount. To know how much CGT you need to pay, here’s how to calculate your net capital gains:
|
Step 1: Determine your sale proceeds |
Take note of the amount you receive when you dispose of a CGT asset. |
|
Step 2: Work out your asset cost base |
The cost base is the sum of the amount you paid to purchase the asset plus other expenses you racked up in the course of acquiring, holding, and disposing of the asset (e.g. stamp duty, transfer and registration fees, ownership expenses, etc.). |
|
Step 3: Subtract the cost from the proceeds |
You have a capital gain if the difference exceeds zero, and a capital loss if it’s negative. |
|
Step 4: Repeat steps 1-3 |
Do the first three steps for each asset if you have more than one CGT event for the financial year. |
|
Step 5: Subtract the capital losses (if there are any) from the capital gains |
Work out the difference between your capital gains and allowable capital losses you incurred in the relevant financial year or carried forward from previous years. |
|
Step 6: Apply the discount method that will yield the lowest possible capital gain |
Check if your gross capital gain is eligible for any discount before reporting it on your tax return. Depending on your CGT asset’s eligibility, you can choose the method that yields the lowest possible capital gain to minimise your tax liability. |
How to minimise capital gains tax
You can’t legally avoid paying capital gains tax, but there are ways to minimise it that let you stay on the right side of the law.
Here are some of the strategies you can employ:
Apply the best method to minimise capital gains
The easiest strategy to minimise CGT is using allowable capital losses to offset capital gains and therefore lower your tax liability. But if you don’t have losses to use or if you still want to yield the lowest CGT possible after the reduction, you can employ any of the following CGT-minimising methods applicable to your asset.
Discount method
As mentioned, any capital gains you (as an Australian individual) make from the sale of an asset you held for over 12 months are eligible for the 50% discount.
Indexation method
If your assets were acquired before 21 September 1999, you may choose to use the indexation method if it yields more favourable results.
This method allows for the adjustment of the asset’s cost base using a multiplier that accounts for inflation, but only up to 30 September 1999, regardless of how long the asset was held after this date.
Under this method, a multiplier called the indexation factor is calculated by dividing the consumer price index (CPI) at the time you sold your asset by the CPI at the time you bought it. To work out the capital gain, the indexed cost base is then subtracted from the selling price of the asset.
To demonstrate how it works, here’s Isaac who chose the indexation method.
Isaac bought an investment property in October 1985 for $200,000 (all fees included) and sold it for $700,000 in September 2016. To determine the multiplier, he divided the CPI at the time he sold the asset by the CPI when he bought it, which is 109.4/39.7 equals 2.756 (rounded to three decimals).
He then multiplied what he paid for the property by this figure ($200,000 x 2.756) to give him his inflation-adjusted cost base of $551,200, which brings his net capital gain to $148,800.
By comparison, had Isaac used the discount method, he would have a much larger capital gain of $200,000.
Note that if you index your asset’s cost base, you cannot apply the 50% discount – you can only choose one. The method that you choose locks in once the asset is sold; switching is not allowed.
Keep important records and documents
Holding on to records of all pertinent transactions and events relating to your investment helps you easily establish important dates like acquisition and sale, claim deductions for expenses, and potentially lower your tax payable gains.
Many of the records you need to keep are receipts such as those of purchase or transfer, stamp duty, legal fees, insurance costs, and maintenance and modification expenses. You should also keep records of market valuations and loan details.
It is recommended that you keep these for five years after the CGT event occurs.
Records relating to capital loss are recommended to be kept for a further two years after you use the loss to offset capital gains.
Why you need to consult with experts
Tax laws are complex and subject to change, capital gains included, so staying informed is crucial especially if you intend to become an investor. If you still have questions, consulting with a qualified tax professional is advisable to help you work out strategies tailored to your circumstances while ensuring compliance with current laws and regulations.
Images from freepik
Need help with a home loan?