Capital gains tax is a reality, but, in some cases, it can be avoided or minimised. So it’s essential you do your homework before it comes time to sell your rental property, holiday home or parcel of land.
Here is everything you need to know about capital gains tax and investment properties.
You will likely have to pay capital gains tax on the sale of any property that isn’t your family home.
What is it?
Capital gains tax is the tax you pay on any capital gain (profit) you make from the sale of certain assets, including investment properties. It forms part of your income tax and is payable to the Federal Government.
With the exception of your family home, most property sales are subject to the tax.
When to pay?
Capital gains tax is paid in a lump sum in the financial year that you sell your investment property. As mentioned earlier, it is calculated and then submitted as part of your annual income tax return.
You must pay the tax bill in the same year you sign the contract of sale, not the settlement. Which is something you should be wary of when selling the property towards the end of the financial year.
Exemptions and discounts
Depending on how the market is travelling and how long you have owned an investment property, capital gains tax can be a large amount of money. And so, it’s essential to factor in any deductions you are eligible for.
In some cases, knowing the following tricks could save you thousands of dollars.
If you owned the property for more than a year, you’ll automatically be eligible for a 50% discount on the tax.
Principal place of residence
This is the main exemption when calculating your capital gains tax.
If the property being sold is your family home, then you don’t have to pay tax on it. However, you can only claim this deduction if the property has a dwelling on it and you are living in it.
You can also only have one principal place of residence at a time.
If claiming this exemption, you will have to prove it is your principal place of residence. For example, you will have to prove that you have personal belongings stored there, receive mail at that address, and have no other property nominated as your home.
Temporary absence
If you move out of your home and rent the property, there is a special six-year rule that applies.
This means the residence will be exempt from capital gains tax if you sell within the first six years of renting it out.
If you continue to rent it out and sell after this time, though, you will have to pay capital gains tax. But if you temporarily move back in, the six-year rule resets.
When done correctly, this can be an efficient means of reducing your capital gains tax in the future. Although, it’s worth noting here that you can’t treat more than one dwelling at a time as your main residence.
A similar ten-year rule applies if you moved out of the property but did not rent it out to a tenant.
Year of purchase
If you purchased your investment property before 20 September 1985, it is exempt from capital gains tax.
Holding investments for 12 months
If you hold an investment property for longer than a year, you are entitled to an automatic 50% discount on any capital gains tax.
For example, let’s say Joe owns a property that is not his principal place of residence.
He holds it for 15 months and sells it for a profit of $20,000.
Under the current Morrison government, Joe only has to declare a capital gain of $10,000, which is added to his taxable income.
Even if you gift a property to a friend or family member, you’ll still need to pay capital gains tax.
Making an investment property your home
If you buy a property, rent it out for a year, and then move in, you can still apply for a partial exemption.
To work out what you owe, you must compare the amount of time you rented the property with the amount of time it has been your home.
This comparison will then be used to apply for a partial exemption.
Making income from your home
If you choose to rent out a room within your home, you will be liable to pay capital gains tax when you sell.
You will have to pay tax based on the proportion of the floor space used to generate an income.
Remember, you can also deduct a portion of your interest expenses.
Even if you rented out the property at one point, you still may be entitled to a full capital gains tax exemption.
Transferring to a relative or friend
If you pass on an investment property to friends or family, capital gains tax still applies.
You will not be able to dodge capital gains tax by giving land as a gift or selling it for below market value. In these cases, you will need to know the market value of the property on the day of transfer, as this will be considered the sale price, regardless of what was actually paid by your relative or friend.
There are also certain circumstances when special rules apply, such as when the transfer occurs as part of a relationship breakdown. For more information, visit the Australian Tax Office website, or speak to your accountant.