Perhaps one of the most significant considerations when it comes to investment properties is Capital Gains Tax (CGT). Whilst this is something that only comes into effect on disposal of the asset, it is important to be aware of how it works and the potential effects on your earnings. While investing in property can be an exciting and rewarding experience, it is not something to be undertaken without adequate research and preparation.
A capital gain is the difference between the buy and sell price of an asset. CGT is paid on any capital gain (essentially, profit on an asset) that you make in any given financial year. There is no separate tax on capital gains; any profit is included in your annual income tax return and considered a part of your taxable income. As a result, you are taxed on your net capital gain at your relevant marginal income tax rate.
Your net capital gain is calculated from your total capital gains for the financial year minus your total capital losses (this includes any net capital losses that are carried over from previous years) minus any CGT exemptions and/or concessions to which you are entitled.
There are many events that could take place that will have a CGT effect, these are known as ‘Capital Gains Tax Events’. The most common CGT event takes place when you dispose of an asset, such as an investment property. As a rule of thumb, whenever you are changing ownership of an asset it is more than likely that the transaction will have some Capital Gains Tax consequences. However, the disposal or transfer of your principal place of residence generally does not attract CGT.
In most cases, disposing of an investment property means it is likely that some amount of CGT will be payable. However, there are a range of exemptions and concessions that are available for various investment property circumstances.
People’s lives are constantly changing and as such there are many reasons why you may decide to lease out part, or all, of your principal place of residence at one time or another. In order to do this without incurring CGT, or to minimise your liabilities as much as possible, it is important to be aware of the ATO’s guidelines with regards to CGT exemptions.
The following simple rules apply:
• Only your main place of dwelling will be exempt from CGT. Thus you can’t own two properties, live in one for a couple of years and then alternate between that property and your main residence in order to avoid CGT on both houses.
• Usually, if you purchased a house after 7.30pm on 20 August 1996 you are required to have lived in it when it was first bought (i.e. not rented it out) to be entitled to a full exemption. This is because if you rent the house out straight away the ATO deems you to have acquired the property purely to produce income and you will be liable for CGT as a result.
• Provided the above terms are met, you may be exempt from CGT if you rent out your home (principal place of residence) for less than six years. Once that period of time has elapsed you must return to live in that house for an acceptable amount of time in order to be allowed another rental period of six years. This process can generally be repeated for any amount of time and the property will remain exempt from CGT. The same can also be said if you rent the property out for six years, then leave it vacant from there on in. A tax payer can often still apply the six year exemption rule if they acquire and reside in another property. However there is no ‘Main Residence’ exemption applied to the second property which subsequently becomes subject to Capital Gains Tax.
• In situations where multiple investment properties are acquired over a period of time, the ATO sees the six years as cumulative. This denotes that you only get six rental years in total before you are liable to pay CGT. Fortunately the CGT will be exacted proportionately. As a general example, this means if you reside in your main residence for twelve years before you rent it out for eight years, and made a $200,000 capital gain on the property after that, you will only have to pay CGT for the two year period that exceeds the six-year exemption. Thus the CGT would be exacted on $20,000 (being two years excess over a six year period divided by a total of twenty years owned).
• If you’ve held a property for more than twelve months and the ATO has deemed you subject to CGT, you will usually be entitled to a 50% discount.
Anyone subject to CGT should be aware of the following rules:
• Properties owned by private companies do not qualify for any CGT exemptions or concessions.
• If you have purchased a new property but are still in the process of selling the old one, you need to complete the sale within six months in order to avoid CGT on the first property.
Here at The Quinn Group, our experienced team of accountants and tax agents can assist you with all of your Capital Gains Tax needs. For more information on CGT or for any other tax or accounting advice submit an online enquiry or call us on 1300 QUINNS (784 667) or on +61 2 9223 9166 to book an appointment.