What is Capital Gains Tax?
Capital gains tax (CGT) is a thorn in the side of property investors who like to buy, score a lot of capital growth and sell.
Just like in many other parts of life, it’s an example of the government waiting until you’ve done the hard work and made some money, then coming over the top and taking a slice of your pie. Essentially, the more value growth you achieve, the more tax you’ll have to fork over.
What am I up against?
If you sell an investment property or another asset, like shares for example, you will be subject to tax on a portion of the increase in value. When you realise a capital gain, it’s added to your assessable income and can therefore put a rocket under your tax bill.
Introduced in Australia in September 1985, CGT applies to all investment assets acquired since that date, including real estate, shares, cryptocurrency, collectables, and just about anything else you can invest in.
To put it as simply as possible, say you buy a property for $500,000 and then sell it later for $800,000. Your capital gain is $300,000 and you will be taxed on that amount.
So how much do I pay?
It’s different for everyone. The gain you realise is added to your income in whatever year you sell the property (based on when you sign the contract, not when you settle), so the amount you pay will depend on how much other money you have earned that year and what you can deduct from that amount. For your own specific situation, you can find free online CGT calculators that will help you figure out what you pay.
The amount of CGT you pay can also depend on how long you own the investment property. If you own it for longer than 12 months, you are eligible for a 50% discount on your capital gains…as in only half of the gains will be rolled into your assessable income.
If you flip and sell the property in less than one year, you have to pay the full amount. This discount was put in place to encourage investors to provide rental accommodation for longer periods. If flipping and selling for a profit is your strategy, you can therefore save thousands of dollars by renting the property out for a year before selling it.
When don’t I have to pay CGT?
CGT doesn’t apply to your principal place of residence (PPOR), only to investment properties, so if your family home has skyrocketed in value over the generations, you don’t need to worry.
If you move out of your PPOR and turn it into an investment property, you remain exempt from CGT if you sell within the next six years. After that it becomes a regular investment property in the eyes of the taxman.
You are also exempt from CGT if you don’t make a capital gain. Say you sell your property for the same amount you bought it, or less, you don’t have any gains to tax.
Also, if you do sell one property for a loss, you can carry that amount into a future tax year so that when you sell another property for a gain, the previous loss is subtracted from the gains you then must pay CGT on.
A tax on sharing
When the share economy was kicking off, a lot of people leapt onto the bandwagon and started renting out rooms or even their entire PPOR on Air BnB to make some extra cash.
The problem being that this now opens them up to CGT on a portion of the gain they make on their family home in the future. This could mean a nasty surprise later down the line for those who didn’t know what they were getting into.
Buy and hold
Most Binvested investors have a buy and hold strategy, in which they create, release and use equity to expand their portfolio and eventually use increased rent to pay down the principal on their properties.
This strategy, if successful, can mean you find yourself one day with a portfolio full of unencumbered properties that are paying you enough income to live off and retire with. Those properties can be sold if needed to pay off other debts or free up capital, but the bottom line is that if you never sell, you’ll never have to pay CGT.