When you sell an asset, you may be liable to pay capital gains tax on your profits. However, there are ways to minimise the amount you owe.
Let’s look at capital gains tax, how it works, and how to minimise it.
What is capital gains tax?
Capital gains tax (CGT) is the tax the government puts on the proceeds you earn from the sale of an asset. For example, if you sell an investment property for more than you bought it, you may have to pay tax on your profits.
Despite its name, CGT is not a separate tax but falls under the umbrella of income tax.
What does capital gains tax cover?
Thankfully, CGT does not apply to everything you sell. If you sell your old jacket on eBay for $80, you will not be charged capital gains tax.
Other asset sales that are exempt from capital gains tax include:
– Cars and motorcycles
– Your primary residence as long as:
– You don’t rent out any part of it
– You don’t use it for business
– It isn’t on more than two hectares of land
– You aren’t a foreign resident, and you do not satisfy the requirements of the life events test at the time the \’CGT event\’ happens
– Personal items (furniture, electrical goods, etc.) that cost under $10,000
– Depreciating assets
– Specific exemptions such as awards and payouts (for a full list, see the ATO website)
There are also exemptions for residents of the Norfolk Islands. Check the ATO website if this applies to you.
So, what does CGT cover?
The big one is investment property. This includes:
– Vacant land
– Business premises
– Rental Properties
– Holiday houses
– Hobby farms
Other CGT-eligible asset sales include:
– Shares and units
– Cryptocurrency (Yes, crypto is taxable)
– Collectables (Not all collectables; see the ATO website for details)
– Intangible assets like leases, goodwill, licences and contractual rights
– Foreign currency
How to minimise your CGT
While CGT is a government tax that must be paid, and it is always advisable to follow the law regarding tax, there are a few ways to lessen the amount you owe.
The Six-Year Rule
One useful loophole you can use to avoid CGT on an investment property legally is the six-year rule.
This rule states you can classify a property as your primary residence up to six years after you move out. This means that if you make the property your primary residence long enough, you can rent it out for up to six years and sell it for a profit without being hit by CGT. This situation may arise because you move overseas or interstate for work and don’t want to sell your place.
This strategy is sound, but you must be willing to adjust it to make it work. Talk to your tax accountant to find out what’s possible.
Revalue before you lease
Another trick for reducing capital gains tax on real estate is to have your home valued before you find tenants.
CGT is calculated at the time the property is first rented, which can be to your benefit.
If your property has appreciated between purchase and tenanting, you can negate this profit by having a valuation. So, if you bought the property for $700,000, you have it valued before you rent it out, and it has risen to $800,000, then, when you sell, you receive $900,000.
Without the valuation, you may be taxed on the $200,000 profit from when you bought the property to when you sold it. By having it valued before the tenants move in, you cut that taxable amount to $100,000. You should also use a professional valuer for market price valuation. Remember, you can’t guesstimate or use valuation from real estate or banks; the ATO prefers independent valuers.
Use the 12-month ownership discount
Any asset you have owned for over 12 months is eligible for a 50% discount on CGT.
Be aware that this only applies to assets owned by individuals or trusts. If you are selling on behalf of a company, you will usually not be eligible for this discount.
The downside of gaining this discount is that your asset wouldn’t have had time to appreciate much if you bought it as an investment.
Work with an accountant
The best way to minimise your CGT is to work with a tax accountant.
They will be able to advise you on which strategies you can apply and help you set up an investment structure that helps keep your CGT at a minimum. Different structures like organising your investments in a fund can help in this regard.
Your accountant can also help with other strategies, like adding funds to your superannuation to lessen your income.
Need help to understand and minimise capital gains tax? Reach out to Tax Integrity.
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