Selling shares or your investment property? Don’t forget about capital gains tax, which you may have to pay after the sale.
Capital gains tax is a term often thrown around when discussing the sale of assets like shares or property. But if you’re new to the concept, you might be wondering exactly what it is, how much capital gains tax you have to pay, and in what circumstances.
To help you navigate this slightly tricky tax, here are a few capital gains tax basics.
What is capital gains tax?
Capital gains tax, also known as CGT, is a type of tax paid when you sell an asset for more than you bought it for. Conversely, a capital loss occurs when you sell an asset for less than what you paid.
CGT is often associated with buying and selling property, but it can also apply to other kinds of assets including:
- Foreign currency
- Items for personal use – such as boats, furniture, electrical goods and other household objects – if you bought the item for more than $10,000
- Collectable items including artworks, jewellery and antiques, if you paid more than $500 for the item
- Licences and contractual rights
- Improvements or additions to your property if you bought the property before 20 September 1985
It’s worth noting that you don’t pay CGT on your main residence – with a few exceptions. You may only get a partial CGT exemption if your main residence is on more than two hectares of land, if you rent out part of it or if it’s also used for business.
You also don’t need to pay CGT on your car or motorcycle, or any wins you make via prizes or gambling. Assets you acquired before 20 September 1985 are also not subject to CGT.
How much is capital gains tax and how is it calculated?
Capital gains is calculated using a few different factors: the length of time you’ve owned the asset, if you’ve incurred any capital losses and your marginal tax rate for the financial year.
That first one is important because it canimpact the amount of tax you have to pay. If you own the asset for at least 12 months, you may be eligible for a CGT discount of 50%.
When it comes to capital losses, you might be able to use any losses you make to lower the amount of CGT you have to pay in that financial year.
Say you sell a bunch of shares and lose money on them, but also make a profit on the sale of your investment property. The loss you incur may reduce how much CGT you pay on your property sale.
And finally, your marginal tax rate can affect how much tax you pay because your capital gains are usually added to your taxable income for that financial year.
When it comes to property specifically, such as an investment property, expenses like stamp duty, agent fees, land tax and even improvements you make to the property can be deducted from the sale price to help calculate CGT.
There are also different rates of CGT depending on whether you’re an individual, company or self-managed super fund (SMSF).
You can learn more about working out CGT by reading our article on how to calculate capital gains tax.
Capital Gains Tax can apply when a property is sold for a profit. Picture: realestate.com.au
What is a CGT event?
A CGT event is when a transaction or event leads to either a capital gain or capital loss.
Selling an asset or transferring it to another person are the most common kinds of CGT events, but they’re not the only ways a CGT event can occur.
Other examples of CGT events include losing or having an asset destroyed; cancelling, surrendering or redeeming shares; no longer being an Australian resident; and many others.
How do you reduce capital gains tax?
Now for the good news: you may actually be able to lower the amount of CGT you pay upon the sale of an asset – or even avoid it entirely.
There are several ways to reduce capital gains tax. These include:
Relying on the main residence exemption. For the most part, your main residence isn’t subject to CGT – aside from a few particular circumstances, such as using your home to earn an income
1. Move out of the home
This is where you move out of your home and continue to treat it as your main residence – either indefinitely or for up to six years if you decide to rent it out during your absence
2. Keep the asset for at least 12 months
Don’t forget that owning an asset for more than 12 months could result in a CGT discount of 50% – be it property, shares or something else entirely
3. Offset your gains with losses
Any capital losses you make can help reduce your net capital gains and, consequently, the amount of CGT you have to pay. Plus, you can actually use capital losses from previous financial years to offset capital gains in current or future financial years.
4. Put your money in super
Investing in your superannuation fund may offer a discount on the CGT you have to pay
Find out more about avoiding capital gains when selling property
When do you pay capital gains tax?
Even though it might appear as a separate tax, capital gains tax isn’t an isolated payment you make whenever you sell something for a profit. Instead, any capital gains are added to your taxable income.
This is where CGT events become important. The year the CGT event happened determines which income year the capital gains will be applied. So if you sell an investment property in the financial year 2022/23 and make a profit, the capital gains will be added to your 2022/23 income.
When you’re reporting your income for the financial year, you’ll be asked to detail any capital gains, capital losses and exemptions.
Is capital gains tax direct or indirect?
Capital gains tax is a direct tax. This means it’s based on the income or gains of the person paying it. Conversely, indirect taxes are added to goods and services and are paid by the consumer. GST is an example of an indirect tax.
As with income tax, CGT is a federal rather than state tax.
Does CGT apply on inherited properties?
If you’ve inherited a property from a deceased estate, you don’t have to pay capital gains tax. But you might be liable for it if you decide to sell the property – depending on a few circumstances.
Like selling your property to someone else, inheriting a property can prompt a capital gain or capital loss – even though no money has changed hands.
This is because ownership is transferred from one person to another. So, do you have to pay CGT on inherited properties?
CGT may apply based on:
- When the deceased passed away
- Whether they were an Australian resident when they died
- When the deceased obtained their property
- Whether it was their main residence or an investment
- Whether the property was sold while you were an Australian resident
Does CGT apply if you transfer or gift a property?
Property can also be passed to family members or friends while a person is still alive. So if the property is transferred into someone else’s name or a gift, are you still charged capital gains tax?
It depends. If the property is a main residence, it’s exempt from CGT. If not, CGT may very well apply. Here’s how CGT can affect the giver and receiver.
Under normal sale circumstances, the capital gain would be calculated by deducting the sale price from the purchase price.
But in the case of transferring or gifting a property, the seller may receive a lower sale price for their property – such as parents selling a unit to their kids for a significantly reduced amount. Alternatively, they may gift the property and receive no money at all.
Regardless of whether or not any money was involved in the sale, the giver can still be liable for capital gains tax. In both cases, if the giver receives less for the property than it’s worth, CGT would be calculated using the property’s fair market value on the day it’s passed on. The capital gain would be the fair market value less the purchase price.
The fair market value approach is used in cases where both parties are not dealing with each other at arm’s length. In layman’s terms, ‘at arm’s length’ means the parties are unrelated and don’t have any control over one another.
So for fair market value to apply, the giver and receiver would have to be related in some way – such as being a family member, partner, shareholder in a company, trust beneficiary and many other examples.
The receiver isn’t liable for CGT, unless of course they decide to sell the property. However, other property and land taxes may apply.
Do retirees pay capital gains tax in Australia?
While retirees and pensioners are free from a number of costs, unfortunately capital gains tax isn’t one of them. Retirees and pensioners are still subject to CGT, unless they qualify for an exemption. These include:
- If they’re selling their main residence, or if they only lived outside their main residence for up to six years
- If they purchased the asset before 20 September 1985
- If the asset is obtained or owned through a self-managed super fund (SMSF), the asset is sold post-retirement, and all SMSF members are in the pension stage