Capital gains tax has a way of hitting property sellers like a bolt from the blue when it comes time to sell their cherished investment property. Indeed, CGT often feels like an unjust attack on your profits. Nevertheless, knowing how capital gains tax is calculated, and how to reduce the potential amount of CGT when selling your investment property, might just leave you with a bigger grin on your face and a larger portion of your capital gains.
Defining capital gains tax
When you eventually do sell your property, the capital gain is the difference between what it cost you to acquire and improve the property (your ‘cost base’) and the amount you receive when you sell it. If you make a capital loss, this can be offset against other capital gains in that financial year or carried forward to future years.
How is CGT calculated and how can you (legally) reduce the amount you pay?
Firstly, it is important to understand that even though you’re selling an investment, the profit/loss is added to your personal income tax. If you’re in a co-owner, the amount will be divided as per your ownership percentage. Naturally, you want to reduce your CGT as much as possible (without breaking any rules!). One way of doing so is to sell your investment during a year of minimal personal income. It’s also important to note that CGT is applied from the contract date, not the settlement date. These may sound like minor considerations but choosing the date to sell your investment could mean the difference of thousands of extra dollars in your pocket!
If you’ve held the property for more than 12 months, you may be eligible for the capital gains tax discount. This means that only 50% of your capital gain is assessable. So, if you make a capital gain of $100,000, only $50,000 will be added to your taxable income.
There are also a number of expenses you can deduct from your capital gain, which includes:
- agents commission
- staging and advertising costs
- legal fees
- loan discharge fees (if you have a mortgage)
- repairs and maintenance preparing the property for sale
You can also claim the balance of any structural improvements made to your investment property during the time you owned it.
How to reduce your CGT
Obviously the 12 month rule is important, but that’s not the only way to reduce CGT and keep as much of your hard earned profits as possible.
You could look to minimise your taxable income where possible with superannuation contributions (personal contributions or salary sacrificing) and maximise all tax deductions relevant to your circumstances. For example, you could pre-paying expenses on other rental properties (up to 12 months) or undertake any needed repairs and maintenance.
If you have any capital loss making assets, you could also consider selling these in the same financial year, or before, to offset against any capital gains.
Have you heard about the depreciation claw back?
Well, it’s true. Capital works depreciation claimed across the years is reversed upon sale. However, it’s important to note that plant & equipment depreciation is not added back (ie. its only capital works).
Capital works deductions refer to the building’s structure and items considered to be permanently fixed to the property such as kitchen cupboards, doors and sinks.
Capital works is generally depreciated at 2.5% each year which provides investors with a nice deduction, however when the property is sold the total amount of capital works claimed reduces your cost base which unfortunately increases the amount of CGT applicable.
Sounds harsh but keep in mind that depreciation is decreasing your taxable income each year, and the 50 per cent CGT discount is available to those who hold an asset for 12 months or more. Because of this, the deductions claimed throughout ownership are 50 per cent more valuable than the potential increased CGT liability when the property is sold.
Final thoughts
Now, this is all a bit confusing. This is why so many property investors turn to an accountant come tax time. However, when you choose to arm yourself with the most powerful tax help software on the market, you will be able to confidently manage your properties, take the hassle out of tax and have smart tax tools at your fingertips. TaxTank manages CGT seamlessly in 3 simple steps give you complete control.
Let TaxTank take the stress out of capital gains tax this financial year! Start your free trial today and see the difference TaxTank can make when it comes to paying less capital gains tax.
