This is an easy description of how it works:
A common misconception about capital gains tax is that it is charged at a flat rate. That?s not the case.
?The amount paid depends on your marginal tax rate and that depends on the income you generate,?.
This means it can be tax effective to time the disposal of an asset so that the sale goes through in a year when the person?s taxable income will be lower.
?Sometimes it pays to wait until you are getting towards their retirement and have started taking income from their lower private pension so they don?t have to pay any income tax. Then their capital gain is assessable at a lower tax rate?.
Year Introduced
Capital gains tax was introduced in 1985, the sale proceeds of properties that were bought before 1985 are not subject to capital gains tax.
Tax discount introduced
The capital gains tax discount was introduced on 21 September, 1999. This is a discount of 50% that applies to the capital gain made on assets bought since that date if they have been held for more than one year.
Family home
There is no capital gains tax to pay on the sale of the family home, but many people are confused by the special rules that apply to other properties, such as an inherited home.
Inherited family home
?You don?t have to pay capital gains tax on inherited property unless you sell it. The cost base might change and not be the purchase price but you don?t pay capital gains tax until the property is sold?.
Death Duties
?There are no death duties in Australia and a main residence property acquired from a deceased estate is generally not subject to capital gains tax ?, ?However there are some important rules to consider to ensure the capital gains tax exempt status is not lost.?
Pre-capital gains tax property
Capital gains tax was introduced on September 20, 1985. If the deceased person acquired the main residence on or before September 19, 1985, the following rules apply:
The property is capital gains tax exempt if it is sold within two years of deceased?s death.
It is still capital gains tax exempt if sold after two years, providing the following tests are met:
? The property was not used to produce income (rented out)
? It was the main residence of the person inheriting the property, for example the deceased?s spouse or an individual having a right of occupancy the property under the will.
Post-capital gains tax property
If the deceased person bought their main residence after September 19, 1985, stricter tests apply to determine whether gains on the sale of the property will be subject to capital gains tax.
All conditions noted above must be satisfied. In addition, the property must have been the deceased person?s main residence just before their death and not used to produce assessable income at that time.
Inherited investment properties
Generally, no capital gains tax is payable on the transfer of a property to a beneficiary under a will. Capital gains tax will be applicable when the property is eventually sold by the beneficiary.
The cost base is calculated as follows:
For pre-capital gains tax investments properties the cost base is calculated based on the market value of the property at the deceased date of death.
For post-capital gains tax investment properties the cost base is calculated based on the deceased?s original cost.
The 50% capital gains tax discount also applies to the sale of inherited properties that have been held for more than 12 months.
The rules on when and how much tax applies are not straightforward, particularly when the investment property starts out as the owner?s primary residence, or becomes the owner?s home after having been rented out for a period of time.
?The fundamental principal is that a taxpayer?s main residence is exempt from capital gains tax and that a taxpayer can only have one main residence,?
?Commonly, circumstances can change, especially when the main residence is also used for income producing purposes for certain periods of ownership. Such circumstances include absences from the property and renting out the property for the first time.?
Each person?s circumstances are different and you should seek professional tax advice if you have questions on how capital gains tax applies to your situation.
Primary place of residence becomes an investment & the 6 year rule
Different rules apply when people turn their home into a rental property or move into a property that was formerly an investment. Stephan warns that some mortgages do not allow the property to be converted into an investment. For simplicity, some people like to sell up and buy another similar property rather than converting the property?s use.
The main residence home is rented out as the taxpayer is transferred to another city/overseas or decides to move to rented accommodation and keep the existing home.
Home therefore stops being a ?main residence?.
The ?Six Year Rule? allows the taxpayer to continue to treat the home as their main residence for a maximum period of six years (See Example 1)
If the taxpayer moves back into the property after having rented it out for some time and re-establishes it as the main residence, a further period of six years starts to run if the property is rented again in the future.
If the ?Six Year Rule? is breached, as the property is rented for more than six years, then a partial exemption is applicable (See Example 2)
Additional Rules
In addition to the ?Six Year Rule?, there is also a special rule for properties which first become income producing after August 20, 1996.
The Special Rule relates to determining the cost base of the property.
The property is assumed for tax purposes to have been acquired at its market value when it was first rented out, rather than the actual purchase price.
Example 1:
Dwelling first used to produce income ? ?Six Year Rule?
On July 1, 1994 Bev paid $250,000 for a house that she used as her main residence until July 1, 2007, at which time its market value was $350,000.
If Bev then rented the house until she sold it before July 1, 2013, she would still be able to claim a full capital gains tax exemption by relying on the six-year extended exemption. She would not have to pay capital gains tax on the sale proceeds.
Example 2:
Dwelling first used to produce income ? Breaching the ?Six Year Rule?
Following on from Example 1, if Bev continued to rent the house before selling it for $700,000 on July 1, 2014 (seven years after its first income use), she could only claim a partial exemption for capital gains tax.
In that case, the market value of the house at the time of its first income use ($350,000 on July 1, 2007) is used to determine the capital gain because the property first became income-producing after August 8, 1996.
The capital gain in this case is $350,000 ($700,000 − $350,000 = $350,000).
The taxable capital gain would be worked out (ignoring leap years) as follows:
$350,000 X 365 days (non-main residence days)
2,555 days (days in deemed ownership period) = $50,000
Since Bev has held the property for more than 12 months, a 50% capital gains tax discount would apply. She would have to pay capital gains tax at her marginal tax rate on $25,000 (ie 50% of the $50,000 capital gain).
Investment becomes a residence
Only a partial main residence exemption is available if a property is initially rented out as an investment and then becomes the taxpayer?s main residence for part of the ownership period. If the residence is used as a rental property initially, the overall capital gain on eventual disposal is reduced via a pro rata apportionment by reference to the period the taxpayer used the property as their main residence, as explained in
Example 3.
Example 3: Former investment property- now main residence
Lisa acquired a dwelling on October 19, 2008 which she let out to tenants until October 21, 2011. From that date she used the dwelling as her main residence. Lisa eventually sold the dwelling on September 7, 2013 and made a capital gain of $40,000, calculated without regard to the capital gains tax exemption provisions.
The capital gain is reduced pro rata by reference to the period Lisa used the dwelling as her main residence.
The reduced capital gain is:
$40,000 ? 1,098 (number of days from October 19, 2008 to October 21, 2011)
1,785 (number of days of Lisa?s ownership) = $24,605
As Lisa has owned the property for more than 12 months, she would be entitled to the capital gains tax discount and would have to pay tax on $12,302.50 (50% of $24,605).
The big question that most savvy property investors ask me is ? ?Doesn?t the depreciation I claim on my investment property get added to my capital gains tax??
The simple answer is yes it does, and normally I would say to that person:
?Well there?s one great way of getting around that. Don?t sell your property!!?
There are two parts of the tax depreciation puzzle. Building allowance (the 2.5% you can claim on the structure of certain properties) and Plant and Equipment (things like carpets and blinds and fittings that wear over time).
Only the Building Allowance portion is re-calculated into the CGT equation.
Let me explain in more detail?
Let?s say a property investor buys a property for $200,000 and then sells that property for $300,000. In simple terms, that?s $100,000 in capital gains. However, let?s assume that this property investor claims $10,000 in building allowance.
The building allowance is the structure of the building. If I claim $10,000, It would be reasonable to assume that I would?ve claimed about $20,000 in plant and equipment depreciation as well (ovens and dishwashers etc).
So in this scenario, I??ve claimed a building allowance of $10,000.
You have to factor in that building allowance. You have to pay capital gains tax in simple terms on the $10,000 you just claimed on the building allowance. So the new capital gain you have to take into account is $110,000.
The good news is that ? If I own the property for more than a year the ATO lets me half my capital gain liability when it comes to pay the CGT tax.
Therefore the CGT liability on the building allowance I have claimed is only $5000 and if I?m on the 45% percent tax rate, I?ve got to pay $2,250 in capital gains tax on the $10,000 that I just claimed.
Following me so far? I just also claimed $20,000 in plant and equipment.
But guess what?
There?s no CGT on plant and equipment because when I sell my property it gets sold at the written down value (provided no written down values are included in the contract).
So there?s $0 payable for CGT on the $20,000 that I just claimed for the depreciation of the plant and equipment.
So the total value of depreciation that I?ve claimed was $30,000 and based on my 45 percent tax rate I?ve managed to effectively get back in my hand is $13,500!
The total amount of CGT on that $10,000 that I?d paid is $2,250. But I?ve claimed $30,000 in depreciation, which resulted in tax benefit of $13,500 ? but I?ve got to pay back $2,250 in CGT.
So my net gain by claiming depreciation is $13,000 ? $2,250 = $11,250.
Would you want to CLAIM IT? I would.
It took me a long time to come to come up with a simple scenario where I could explain the mathematical equation of CGT building allowance, plant and equipment and your net liability.
Brand spanking new property depreciation
How can new properties help investors with their cash flow?
Buying new property will help investor cash flow due to greater tax depreciation benefits. Tax depreciation benefits are at their greatest when the property is brand-new, which maximises your available tax deductions and means a significant boost to your cash flow position.
Exactly how can a new property depreciation benefit an investor?s tax position?
Depreciation allowances for new properties can yield big tax breaks. Investors can claim 2.5% depreciation allowance of the construction cost plus you?ll also be entitled to claim the full amount of depreciation allowance on plant and equipment items such as blinds, ovens, carpets, air conditioners etc, which will all be brand new.
By way of example, the owner of a brand-new Melbourne high-rise unit, recently purchased for $440,000 claimed $12,000 in depreciation in the first year.
Investors also have the option of having a variation on their take-home pay by having the depreciation schedule sent to their employer. Varying your tax withholding will assist property investors with their cash-flow on a more regular basis.
What should investors do to maximise their tax benefits?
A dollar today is worth more than a dollar tomorrow so deduct items as quickly as possible. Individual items under $300 can be written off immediately.
A microwave for example, bought for $330 depreciates at 37.5% but at $295 it?s 100%.
You can also try to buy items that depreciate faster. Items between $300 and $1000 fall into the Low Pool Category and attract a higher depreciation rate. So for instance, a $1200 television attracts a 20% deduction while a $950 TV deducts at 37.5% per annum.
The ownership structure of your investment property should also be a key consideration for investors.
For multiple owners of a property, ask your quantity to surveyor to split the value of assets in the property against the split of ownership rather than one report that is divided by the number of owners at the end.
Doing so will significantly increase your tax deductions as numerous items will be pooled into lower categories that attract higher depreciation rates.
Furnishing your investment property is also a good way to maximise your depreciation because they attract higher rates. For instance, $20,000 worth of furniture could equal $10,000 in year 1 ? but investor?s must be smart about their purchases.
Are the tax benefits best in the first few years? Why?
If you claim using the Diminishing Value (DV) method you claim a greater proportion of the asset?s cost in the earlier years of its effective life.
Using the Prime Cost (PC) method you claim a lower but more constant portion of the available deductions over the life of the property.
The ATO also allows plant & equipment items to be given a new effective life from settlement date, whether new or second hand and regardless of age.
Therefore plant and equipment items can be re-valued based on the purchase price of the building at their settlement date.
Most investors employ the diminishing value method, as depreciation deductions under this method are higher during the first five years of ownership.
This means investors receive a greater deduction in the early years, when it is often most required.
Can you provide an example of the difference between the depreciation of a new property and an older one?
Brand new house $500,000
Year 1 $14,000
Year 2 $10,000
Year 3 $9,000
Year 4 $8,000
Year 5 $8,000
Total $280,000 (40 years)
(source: google)
