What is capital gains tax? Your questions answered

Money and Life
(Financial Planning Association of Australia)

There are only two things certain in life – death and taxes – and let’s face it, nobody likes the idea of either!

And while paying tax is something that most of us just grin and bear, it’s one of those necessary inconveniences that help ensure we continue to enjoy the quality of life we often take for granted living in this great country.

But one tax that does look a little daunting and still sparks confusion amongst Aussies is the Capital Gains Tax (CGT). So, what is it?

What is Capital Gains Tax? 

Introduced in Australia on 20 September 1985 by the Hawke/Keating Government, CGT is a tax incurred when you make a profit through selling any asset – such as shares, property, fixed income or cash – that has resulted in your wealth growing. This profit is called the ‘capital gain’ and will be added to your assessable income in your tax return for the year, based on your marginal tax rate.

How much do you pay in CGT?

If you buy and sell an asset within one year, you’re required to pay tax on the entire amount (100 per cent) of any gain you’ve made. However, if you sell that same asset after 12 months (for a profit), as an individual, you could receive a 50 per cent discount on any gain made.

Conversely, any capital loss resulting from selling an asset, can be deducted from any capital gains made from other sources of income, thereby reducing the amount of tax owing from your overall tax return.

What’s exempt from the CGT?

Assets that you are exempt from paying CGT include your ‘main residence’ – the family home – your car, or the sale of an asset acquired before CGT was introduced on 20 September 1985.

However, if you live on a property that’s larger than two hectares or the land is being used to rent or run a business, you cannot claim the CGT main residence exemption.

And if you are a foreign resident, you may no longer be entitled to claim the main residence exemption when selling your residential property in Australia. In the 2017–18 Budget, the Government announced that foreign residents will no longer be entitled to claim the main residence exemption when they sell property in Australia. This change is not yet law and lapsed with the 2019 election.

Legislation has been reintroduced to parliament in October 2019 and if passed, a foreign resident at the point of selling their home in Australia may not be entitled to claim the main residence exemption. To find out more, refer to the Australian Taxation Office (ATO) guide to foreign residents and main residence exemption.

Capital gains tax generally doesn’t apply when you inherit property, however, you may lose your full ‘main residence’ exemption from CGT if it includes a granny flat that’s earning rental income. As a result, you may be required to pay CGT on part of any capital gain made when you sell your family home.

Click here for a full list of CGT tax exemptions.

How to calculate your capital gain (or loss)

When trying to work out how much CGT you’ll pay when selling an asset, simply take the selling price and subtract its original cost and any associated expenses (like legal costs, stamp duty, and broker fees).

What you’re left with is your capital gain (or loss).

Assuming you’ve made a profit, and have held an asset for more than 12 months, you can apply the 50 per cent discount to establish your net capital gain.

As an individual, the rate of tax paid on capital gain is the same as your (marginal) income tax rate for that year. However, for self-managed super funds (SMSFs), the tax rate is 15 per cent and the capital gain discount is 33.3 per cent (instead of 50 per cent for individuals and nil for companies).

Another way to pay CGT

As an alternative to applying the 50% discount on CGT that is eligible on all assets owned for more than 12 months, you may choose to apply what’s called an indexation method provided you:

  1. acquired an asset before 21 September 1999; and
  2. have held it for at least 12 months.

To account for inflation on the cost base of your asset (up to September 1999), an indexation factor is worked out using the consumer price index (CPI), which is designed to measure the price of inflation for all Australian households.

It’s calculated by dividing the CPI at the time you sold your asset by the CPI at the time you bought the asset. You then add that number to your initial cost price to get your inflation-adjusted purchase price, and finally take away that amount from your sale price.

It’s also important to remember that if you’re an Aussie resident, CGT applies to your assets anywhere in the world, even that nice one bedroom apartment in Paris, overlooking the Champs-Élysées.

Unsure of the CGT implications arising from locking-in the profit (or loss) on any assets you own? A CERTIFIED FINANCIAL PLANNERŽ professional can guide you through everything you need to know, by making it part of your overall plan for less money stress, and better financial wellbeing.

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Categories: Tax