As with most financial matters, capital gains tax can look daunting from afar. But edge a little closer and you begin to see it’s not quite as confusing as you initially thought.
Here’s what you need to know to get your finances in order.
What is Capital Gains Tax?
Capital gain is the difference between what you paid for an asset (less any fees incurred during the purchase) and what you sold it for (likewise less any fees incurred during the sale).
Capital gains tax (CGT) is the levy you pay on the capital gain made from the sale of that asset.
It applies to property, shares, leases, goodwill, licences, foreign currency, contractual rights, and personal use assets purchased for more than $10,000.
Your car, main residence, depreciating assets used solely for taxable purposes, and assets bought before 20 September 1985 are exempt from the tax.
However, if your main residence sits on more than two hectares of land, or you’ve not lived in it for the entire period of ownership, you’ll only be afforded a partial CGT exemption on your home.
How much is capital gains tax?
This is where you find out that ‘capital gains tax’ is a bit of a misnomer; it’s not actually a stand-alone tax; it’s part of your income tax.
If you’ve bought and sold your property within 12 months, your net capital gain – the difference between the sum of your capital gains and the sum of your capital losses – is simply added to your taxable income, which, in turn, increases the amount of income tax you pay.
However, if you’ve owned the property for more than 12 months, calculating your final taxable income is a little bit more complicated than adding your net capital gain to your earned income.
Unless, of course, you’re a business. In that case, you’re not eligible for any discounts (explained below) and simply pay a 30% tax on your capital gains. Meanwhile, self-managed super funds apply a 33.3% discount to their capital gain, and pay 15% tax on the remainding amount.
How do I calculate capital gains tax?
As discussed, if you’ve bought and sold your property within 12 months, your capital gain is simply added to your taxable income.
But for individuals who owned their property for longer than 12 months before selling it, there are two different methods used to calculate CGT: discount and indexation. Subject to eligibility, individuals can choose the method which leads to the lowest possible capital gain.
1. CGT discount method
If you’re an Australian resident who has owned your property for more than 12 months, you’re eligible for a 50% discount on your capital gain.
That’s to say, if you made a capital gain of $100,000 from selling a property that you owned for more than 12 months, and sold it sometime after 21 September 1999, you would only add $50,000 to your taxable income.
2. Indexation method
If you’re an Australian resident and purchased your property before 21 September 1999, you can use the indexation method to determine how much capital gain you will need to add to your taxable income.
This method applies a multiplier to your initial layout, to account for inflation. (Think of it as the tax equivalent of saying, “in today’s money, that would have been…”.)
As a result, your initial purchase price is increased and capital gain thereby reduced.
The multiplier you use is called the ‘indexation factor’. It’s calculated by dividing the consumer price index (CPI) at the time you sold your property by the CPI at the time you bought the property, rounded to three decimal places. You can find a table of Australia’s historical CPI rates here.
Using this method, you are only allowed to index the elements of your cost base up to 30 September 1999, regardless of how much later you actually sold your property.
Once you’ve worked out your multiplier, simply apply this to your initial cost price to get your inflation-adjusted purchase price. And then work out your capital gain by subtracting this amount from your actual sale price.
To make that a little clearer: let’s say you purchased a property for $200,000 (including stamp duty and other fees) on 20 August 1990, and sold for $500,000 (after accounting for associated fees) on 20 March 2018.
First, you’ll need to work out your indexation factor. Assuming you settled and paid the deposit in the same quarter, you’d work this out by dividing the CPI in the third quarter of 1999 by the CPI in the third quarter of 1990 (remember: you are only allowed to index the elements of your cost base up to 30 September 1999): 68.7/57.5 = 1.195 (after rounding to three decimal places).
Second, to work out your inflation-adjusted purchase price, you would need to multiply $200,000 by 1.195. This would give you a revised cost base of $239,000.
Your capital gain would therefore be $500,000 minus $239,000, which is $261,000. You’d then add this $261,000 of capital gain to your assessable income for the tax year of 2018.
3. Capital loss method
In order to reduce the amount of tax, if you’ve made a capital loss you can deduct this from your capital gains (gains you’ve made from other sources).
If you don’t have any other capital gains during that income year, you can ever carry capital losses overt to other income years to bring the tax down then.
When does it apply?
Capital gains tax is a part of your income tax. And so your net capital gain forms part of your assessable income in whatever tax year you sold your property.
How to avoid capital gains tax?
The best way to reduce how much tax you pay on your capital gains is to keep hold of all relevant receipts.
Any costs incurred during the purchase or improvement of the property can usually be added to your cost base. And the higher you can prove your cost base to be, the lower your capital gain.
For more information on how to avoid capital gains tax read: How to avoid capital gains tax when selling property
What happens if I make a capital loss?
You should keep any relevant paperwork that proves you made a capital loss, as this loss can be carried across into future tax years and deducted from future capital gains.
For example, if you make a capital loss of $50,000 in 2018 and a capital gain of $100,000 in 2019, you can subtract the 2018 loss from the 2019 gain, leaving with you a net capital gain of $50,000.
Then, if you’re eligible, you can apply the 50% discount on the remaining $50,000, leaving you with a final capital gain of $25,000, which you can then add to your assessable income.
Unfortunately, you can’t subtract capital loss from your assessable income, to reduce how much tax you pay.
For example, if you make a capital loss of $50,000 on a property sale and earn $50,000 from employment income that same year, you still have to pay tax; you can’t simply subtract your capital loss from your employment income, to reduce it to $0 for tax purposes.
That said, the ATO doesn’t impose a time limit on how long you can carry forward a net capital loss. Which means, if you made a capital loss in 2015 and didn’t make a capital gain until 2018, you can still subtract that 2015 loss from that 2018 gain.
For more information, visit the Australian Tax Office website, or speak to your accountant.
This information is of a general nature and does not constitute professional advice. You should always seek professional advice in relation to your particular circumstances.