Capital Gains Tax (CGT) is one of those things that property investors spend a lot of time worrying about and not a lot of time really trying to understand. You're not wrong to be concerned. Understanding what is capital gains tax on investment property is vital if you're going to properly manage and make the most of your portfolio.
What is Capital Gains Tax? How does capital gains tax work on investment property? What are the rates? Does rent count towards Capital Gains?
The Australian taxation system has specific provisions for Capital Gains Tax on investment properties. In this comprehensive guide, we'll explain how does capital gains tax work on investment property, when it applies, calculation methods, and strategies to manage your obligations effectively.
What is Capital Gains Tax on Investment Property?
Unlike a lot of other countries, Capital Gains Tax is not a separate tax but forms part of the income tax system in Australia. It applies to the profit made when you dispose of an investment property (assuming it was acquired after September 19, 1985). Key things you need to remember include:
- CGT is triggered by a "CGT event" – typically the sale or disposal of property.
- It applies to the "capital gain" – the difference between cost base and sale proceeds.
- The rules are different for foreign investors.
- CGT is integrated into your annual income tax assessment.
Do You Pay Capital Gains Tax on Investment Property?
Yes, investment properties in Australia are generally subject to CGT, unless:
- The property is your principal place of residence (PPOR).
- You acquired the property before September 20, 1985.
Certain small business assets may also qualify for concessions, and there are special rules apply for inherited properties. Finally, remember that CGT is only payable when a "CGT event" occurs.
What Percentage is Capital Gains Tax on Real Estate?
What percentage is capital gains tax on real estate depends on your situation. You should always seek expert tax advice for your individual circumstances, but as an indication here are some general rules:
- CGT is calculated as part of your income tax, at your marginal tax rate.
- Foreign residents face specific CGT withholding rates (12.5%).
- Individual resident investors can access a 50% discount on assets held longer than 12 months.
- Companies pay CGT at the corporate tax rate (25-30%) with no discount.
In practice, that typically means an effective tax rate ranging from 0% to 23.5% for individuals after applying relevant discounts.
How to Calculate Capital Gains Tax on Australian Investment Property
That might make calculating your CGT sound complex, but it's really just a case of gathering the information and following a few simple steps. If you want a definitive answer, you should seek professional advice, but in these five steps you can calculate your capital gains tax on investment property:
- Determine your capital proceeds (this is typically the sale price).
- Calculate your cost base, including:
- Your original purchase price
- Incidental costs associated with the acquisition (legal fees, stamp duty, etc.).
- Ownership costs not claimed as tax deductions (e.g. depreciation on assets).
- Capital improvement costs (e.g. plumbing or electrical upgrades).
- Costs of disposal (agent's commission, legal fees, etc.).
- Subtract the cost base from capital proceeds to find the gross capital gain.
- Apply any eligible discounts or concessions.
- Add the resulting net capital gain to your assessable income.
When Do You Pay Capital Gains Tax on Investment Property?
It's also important to know when do you pay capital gains tax on investment property, and that depends on a few specific factors.
First, remember that the CGT event date is usually the contract date and not the settlement. This is important if the contract and the settlement fall in different tax years. When you're calculating the gain/loss, you do so in the financial year of the CGT event.
That means the payment is made as part of your income tax obligations, i.e. there is no separate payment system for CGT, so you need to calculate, declare and pay everything at the same time as the rest of your income.
Keep in mind too that if you make a very large gain, the ATO may require you to make provisional payments rather than waiting for one lump sum. This helps the ATO collect the tax and reduce tax avoidance, but in practice it can also help your cashflow by spreading the payments.
How to Defer Capital Gains Tax on Real Estate
If you prefer to defer capital gains tax on real estate, there are several options depending on your circumstances:
- Property rollover provisions: In the context of some business restructures, involuntary disposals, or marriage breakdowns, you might be able to defer payments until a later CGT event.
- Small businesses: Eligible small businesses can reduce or defer CGT through concessions like the 15-year exemption, 50% active asset reduction, retirement exemption, or rollover relief.
- Partial main residence: If you also used your investment property as your main residence for a portion of time, you may be able to reduce your CGT liability in line with that share of time.
- Six-year absence rule: If your property was your main residence, you can usually treat it as such for up to six years even after you start renting it out, which can effectively eliminate your CGT liabilities.
- Timing strategies: If you plan your sale carefully, you can time it so that it falls in a year when your income is otherwise lower, reducing your overall tax liability.
- Self-managed super funds: Holding investment property in an SMSF attracts a lower CGT rate of 10% for assets held over 12 months. If sold during retirement phase, CGT may be entirely tax-free.
- Capital losses: Losses on other investments can be offset against your CGT, another way that careful timing could reduce your obligations.
Is Rental Income Taxed as Capital Gains?
No. Rental income is not taxed as capital gains. Rental income is treated as ordinary income, not capital gains. Capital gains arise only from property disposal.
That means rental income is taxed at your marginal rate, and your rental expenses are generally deductible. While rent isn't subject to CGT, therefore, you need to carefully consider your investment strategies for income and capital implications and keep careful records for both.
The Capital Gains Tax Rate for Investment Property
Depending on your exact circumstances, your effective CGT rate will be different. At a base level, the capital gains tax rate for investment property is generally your individual marginal income tax rate (ranging from 0% to 45% plus the Medicare levy).
But before applying that rate, you can offset any capital losses. You could also be eligible for a 50% discount for assets held over 12 months. Companies and foreign residents (since 2012) aren't eligible for the discount, but if you are then you can account for the discount, add your net gain to your assessable income, and calculate your total obligations.
Special Circumstances Affecting CGT
As well as offsetting your losses and the 12-month discount, there are other circumstances where your level of CGT may be different:
- Deceased estates and inherited properties: If you inherit your property, you don't pay CGT unless and until you sell, based on the deceased's purchase date and price, though you may be eligible for main residence exemptions.
- Compulsory acquisitions: If your property is forcibly acquired (e.g., by the government), you may qualify for a CGT rollover, deferring tax if you use your compensation to buy a similar property.
- Partial disposals and subdivisions: If you only sell part of your property or you subdivide your land, it does trigger a CGT event but tax is calculated on the portion you sell, even if you retain some of the land.
- Expatriates: Since 2012, you lose access to the main residence exemption when selling your former home if you live abroad, meaning you may owe full CGT on the entire gain, with no 50% discount.
- First-time overseas investors: If you're a foreign investor, you pay CGT on Australian property and may face a 12.5% withholding tax on sales over $750,000, with limited access to CGT discounts or exemptions.
Tax Planning Strategies for Property Investors
That's a lot of different rules, exemptions, and technicalities. But there are also a lot of opportunities. By understanding how capital gains tax works on investment property and how your circumstances map onto the CGT rules, you can potentially plan and manage your sale in a way that reduces what you need to pay. At the same time, keeping on top of things ensures you don't fall foul of the ATO.
For effective CGT management, make sure that you:
- Keep full and accurate records from acquisition.
- Time your disposal strategically, remembering that it's the contract date and not the settlement date that's most important.
- Identify all the cost base additions that apply to your sale.
- Make the most of every eligible exemption and concession.
- Incorporate CGT planning into your broader investment strategy, so that you can plan your spending and tax in a fully coherent way.
- Seek professional tax advice for complex situations.
Like anything to do with tax, CGT can be complicated, especially if you haven't done your homework and planning. By approaching CGT strategically, taking the time to understand the system, and making clear-headed decisions, you can keep on top of it and make the most of your investment property.
Frequently Asked Questions (FAQs) About Capital Gains Tax on Investment Property
What is capital gains tax on investment property in Australia?
Capital gains tax in Australia is not a separate tax but forms part of the income tax system. It applies to the profit made when you dispose of an investment property that was acquired after September 19, 1985. The tax is calculated on the difference between what you paid for the property (plus eligible costs) and what you received when you sold it.
How does capital gains tax work on investment property?
When you sell an investment property, the difference between your cost base and the sale proceeds is your capital gain. This gain is then added to your taxable income for the financial year in which the CGT event occurred. For properties held longer than 12 months, individual resident investors can access a 50% discount on the capital gain.
Do you pay capital gains tax on investment property if it's your main residence?
No, you generally don't pay CGT on your principal place of residence. However, if the property was used for investment purposes during some periods of ownership, a partial CGT liability may apply for those periods.
What percentage is capital gains tax on real estate?
There is no fixed percentage. CGT is calculated at your marginal tax rate, which can range from 0% to 45% plus the Medicare levy. After applying the 50% discount for assets held over 12 months, the effective rate for individual investors typically ranges from 0% to 23.5%.
How to calculate capital gains tax on investment property?
To calculate CGT: 1) Determine your capital proceeds (sale price), 2) Calculate your cost base (purchase price plus eligible costs), 3) Subtract the cost base from capital proceeds, 4) Apply any eligible discounts or concessions, 5) Add the resulting net capital gain to your assessable income.
When do you pay capital gains tax on investment property?
CGT is paid as part of your annual income tax return. The CGT event is usually triggered on the date of the contract of sale, not the settlement date. You calculate and declare the capital gain or loss in the tax return for the financial year in which the CGT event occurred.
How to defer capital gains tax on real estate?
You can defer CGT through several strategies, including: property rollover provisions, small business concessions, the six-year absence rule for former main residences, timing your sale strategically, using self-managed super funds, or offsetting capital losses against your gains.
Is rental income taxed as capital gains?
No, rental income is treated as ordinary income and taxed at your marginal rate in the year it's earned. Capital gains tax only applies when you sell or dispose of the property.
What happens if my investment property makes a capital loss?
Capital losses can be offset against capital gains but cannot be offset against other types of income. If you don't have enough capital gains to offset against in the current year, the capital loss can be carried forward indefinitely to offset against future capital gains.
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