Discovering how to avoid capital gains tax when selling your investment property can save you thousands of dollars. Yet so many first-time property investors continue to be overwhelmed at the thought of potentially paying capital gains tax on the hard-earned growth of their investment.
We have put together a ‘how-to’ guide that will show you how you can considerably reduce the amount of capital gains tax you pay and how you can avoid paying it at all.
What Is Capital Gains Tax (CGT)?
According to the Australian Tax Office (ATO), when you sell your property, the difference between how much you paid for it and how much you sold it for, is known as capital gains. Suppose you lost money on the sale of your asset. In that case, the difference will be a capital loss.
Any profit on the sale of your investment property is considered a capital gain, and you will need to declare it on your annual income tax return.
When Is CGT Payable?
Unless expressly excluded, you are required to pay CGT on the sale of your investment property, if you acquired it after 20 September 1985.
The gain from the sale of your property is added to your income tax return for the relevant income year.
The capital gain on the sale of your investment property is likely to push you into a new tax bracket. If that’s the case, then you may be required to pay a more considerable amount of income tax for that particular financial year.
How To Avoid Paying Capital Gains Tax In Australia
The ATO offers its taxpayers a few concessions and exemptions when it comes to paying CGT.
The following list will offer some insight into how to avoid capital gains tax when selling your investment property.
- The Principal Place of Residence Exemption
As a general rule, you can avoid capital gains tax when selling your investment property if that property is your primary place of residence (PPOR).
This rule exists because you usually don’t generate an income from living in your own home. So, you won’t need to declare any profit on the sale of your home on your annual income tax return.
The ATO considers a property to be your PPOR if:
- you and your family has lived in the property for the full duration that you’ve owned it;
- you keep your possessions in the home;
- you use the address to receive your postal mail; and
- the utilities are connected and in your name.
Moreover, you’ll need to live in the property for a minimum of 6 months, from the settlement date, for it to be considered your PPOR.
- The Capital Gains Tax 6-Year Rule
The CGT 6-year rule allows you to use your PPOR as an investment, by renting out, for a period of up to six years. So, if you decide to sell the property within the six years, you would be exempt from paying CGT as you would if you sold the house that you primarily reside in.
The benefit of the CGT 6-year rule similarly appeals to homeowners who want to make some extra money for the time that they are not, for whatever reasons, able to stay in their home – without prompting the need to pay CGT upon its eventual sale.
Example 1:
John purchased his first home in Melbourne in 2014. It has been his PPOR for the entire time that he has owned it. He lived in it for four years before being offered a job in Brisbane.
The job placement was only for two years, so he decided to temporarily move in with his sister and hold onto his house in Melbourne. As a result, he did not need to treat any other home as his PPOR.
Throughout the period that he was away, he rented out his house in Melbourne to generate some extra income and not have the house standing empty.
After the two years, in 2020, John decided that he enjoyed living in Brisbane and wanted to relocate permanently.
He consequently decided to sell his house in Melbourne. Through learning about the CGT 6-year rule, he discovered how to avoid capital gains tax when selling his investment property.
- How To Avoid Capital Gains When Selling Your Investment Property With A Self-Managed Superannuation Fund
Self-managed superannuation funds (SMSF) have become considerably more attractive to property investors because the SMSF can now borrow money to purchase a property. There are several tax benefits if you purchase your investment property through an SMSF. For example, the fund is only required to pay a 15% tax rate on rental income from the property.
This is substantially lower than other income tax rates in Australia.
Moreover, if you keep the property for more than twelve months, the tax rate on sale will drop from 15% to 10%, i.e you would be eligible for a 33% discount on your CGT upon sale of the property. The most beneficial perk of the SMSF is that when it’s in its pension phase, you will not be required to pay any CGT on the sale of your investment property.
- If You Can’t Avoid Capital Gains Tax, You May Be Able to Reduce It
Even if your property doesn’t meet the eligibility criteria for a full investment property exemption, the ATO provides ways to reduce how much capital gains tax you pay on the sale of your investment property.
4.1. Increasing Your Cost Base With Your Expenses To Reduce Your Capital Gain
If you’re selling an investment property and consequently not eligible to avoid paying CGT, you may want to consider increasing your cost base through your expenses.
Remember capital gain = selling price – cost base.Your cost base = purchase price + expenses (see below) – (grants + depreciation)
The expenses that you can add to your cost base include, but are not limited to:
- Incidental Costs such as your advertising costs, legal fees and stamp duty
- Ownership Costs such council rates incurred but not previously claimed as a tax deduction.
- Title Costs such as the legal fees incurred when organising and defending the title on the property
- Improvement costs should you decide to replace the flooring or install a deck, for example.
By adding expenses to your cost base, you can reduce the capital gains you declare on your annual income tax return. This could lead to a reduction in the amount of CGT that you’re required to pay on the sale of your investment property.
4.2. The 12-Month Ownership Partial Exemption
Suppose you aren’t able to claim a full exemption because your property is not considered your PPOR.
If that is the case, the ATO does provide ways in which you could potentially reduce the amount of tax you pay on the capital gain from the sale of your property. One of these partial exemptions allows you to claim a 50% discount on your capital gains tax if you have owned the property for at least 12 months before selling it.
4.3. The “Years Lived In vs. Years Rented” Partial Exemption
If you decided to turn your rental property into your primary residence at a later date, in other words, you did not move in straight away; then you are eligible to claim a partial CGT exemption.
The discount percentage on your capital gains will be calculated proportionally, according to the years that you rented the property out and the years that you lived in it.
Example 2:
After two years of renting out her first investment property, Cathy decided to move in and declare it her PPOR. Eight years later, in 2020, Cathy decided to sell the property. She made a capital gain of $235,500.
She only has to pay CGT for two of the ten years that she has owned the property:
$235,000 x 2⁄10 = $47, 100.
So, Cathy’s taxable amount is only $47,100.
Key Takeaways
If you are selling a property, you should know that any profit made from the sale is potentially considered a capital gain and therefore subject to capital gains tax. Knowing how to avoid capital gains tax when selling your investment property can save you a pretty penny!
If you hold onto your investment property for at least 12 months, you can qualify for a 50% discount on your capital gain.
Or, to avoid capital gains tax when selling your investment property entirely, make sure your property remains your PPOR. Even if you don’t necessarily reside in it, you could still sell it within six years and capital gains tax property 6-year-rule to qualify for the main residence exemption
How can we help?
If you have any questions or would like further information or you are seeking property tax advice, please feel free to contact our office via email –info@investplusaccounting.com.au or phone 02 9299 7000 to either speak with someone or arrange a time for a meeting so we can discuss your requirements in more detail. You can arrange a free 15 minute no obligation chat to discuss your options. Please arrange an appointment with our office by clicking here
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