When it comes to selling your home, with so many things to think about, you might not have given much thought to reducing capital gains tax (CGT).
It’s an important factor to remember since failing to minimise the amount of tax paid ultimately means less of your home’s sale price back in your pocket.
Let’s talk about the ins and outs of CGT in Australia and how you can reduce the amount you will pay.
What is capital gains tax?
Capital gains tax, or CGT, is a tax rate you pay when any capital assets (like real estate or shares) are sold for profit.
When you sell a property for profit, you must claim those gains on your income tax return at the end of the financial year — unless you are eligible for an exemption or partial exemption from capital gains tax.
If you sell your property for less than you purchased it, this is called a capital loss. You cannot claim this on a tax return, but it can be used to offset future capital gains.
The CGT rate is worked out the same way as the income tax rate. It is calculated in tiers based on your taxable income, known as your tax bracket.
How can I calculate the capital gains tax payable on a property sale?
The first thing to do when calculating the amount of tax you’ll pay is to work out what your capital gains were.
If the purchase price for a property was $500,000 and the selling price is $550,000 (without any other considerations factored in, like depreciation and incidental costs), you have capital gains of $50,000.
Work out the marginal tax rate on your assessable income per the annual tax brackets. This is the rate your capital gains will be taxed at.
To add a bit of complexity, you may also want to consider the cost base of the property. The cost base of an asset takes into account not just the purchase price of the property but also factors like stamp duty, conveyancing costs, transfer and valuation costs, and the other incidental costs to homeowners in purchasing a property.
Cost base also accounts for costs incurred during the course of home ownership, like property taxes, rates and repairs. Note that if you have claimed any of these as tax deductions in the last year, they will not count towards the property’s cost base.
Do I have to pay capital gains tax on my property?
While almost all capital assets sold for profit qualify for CGT, several CGT exemptions are worth noting. These include:
- Assets acquired before 20 September 1985 — Capital gains tax was introduced in Australia in 1985, and assets acquired before that are not subject to CGT. Note that if you acquired property before 20 September 1985, any renovations or additions to the property after that date may be subject to CGT.
- Main residence exemption — Your primary place of residence, if sold, is exempt from capital gains tax. The only reasons you may have to pay CGT on the sale of your main residence is if it is partially leased for rental income, used it for a small business, you are a foreign resident, or the property occupies more than 2 hectares of land. This is called the principal place of residence (PPOR) exemption.
- Granny flats — CGT does not apply when a granny flat is created or demolished in renovations.
- Norfolk Island — If you happened to be one of the residents of the external Australian territory of Norfolk Island before 23 October 2015 and acquired an asset there, these are also CGT exemptions.
For any other property sale — be it an investment property, a holiday house, vacant land, a business premises or other property investment — you must consider capital gains tax as part and parcel of a property sale.
If you have been briefly using your home as a rental property and earning an income from it, you may still qualify for the temporary absence rule. This is a six-year length of time where you can earn rental income from a property and still then claim the PPOR exemption on it afterwards. The main clause to this is that you may not claim another main residence exemption at this time.
What is the CGT Discount, and am I eligible?
There is a capital gains tax discount available to Australian residents who fulfil certain criteria. To qualify for the CGT discount, you have to be an Australian resident for tax purposes and to have owned the property for at least 12 months (the one-year rule).
If you fulfil these two requirements, you’ll receive a 50% discount off the CGT that you pay on your property sale. Instead of calculating your CGT rate as normal, you’ll reduce the profit you sold your property for by 50% and then tax it at your marginal tax rate. Super funds will reduce their capital gains by 33.33% if complying.
You will not be eligible for the CGT discount if:
- You are a foreign or temporary resident
- You use the indexation method (where you can index for the cost of inflation if you have owned the property since before 21 September 1999)
- You first started using it as a rental property or to conduct business in the last 12 months.
You may also receive an extra discount on capital gains tax if you use investment property to provide affordable rental housing to low-mid income earners. This can add up to a 10% discount onto your CGT discount, bringing it up to 60% in total.
How can I reduce capital gains tax on a property sale?
While some capital gains tax may be inevitable, there are things to remember that can reduce the amount of tax you have to pay.
- Take advantage of any discounts and exemptions you are eligible for
- Check the date of the CGT Event to see if you qualify for CGT
- Sell during a low-income year to avoid paying a higher tax rate on it
- Keep the property for at least 12 months (to qualify for a CGT discount)
You may also want to seek professional advice regarding selling via an SMSF, particularly if you are in the retirement phase of your life.
