Capital Gains Tax

By Jason Fittler

Capital Gains Tax is a tax charged on any capital gains arising from the sale of any asset acquired after the 19th of August, 1985.According to the Australian Tax Office:

... "Capital gains tax (CGT) events are the different types of transactions or events that may result in a capital gain or capital loss. Many CGT events involve a CGT asset while other CGT events relate directly to capital receipts (capital proceeds).

The most common CGT event happens when you dispose of an asset to someone else. For example, if you sell or give away an asset, including to a relative. Subdividing land does not result in a CGT event if you retain ownership of the subdivided blocks. Therefore, you do not make a capital gain or a capital loss at the time of the subdivision."

Calculating What You Owe
Capital gains tax is a fact of life (for now at least) and so a cost of investing that must be accounted for in your calculations. This does not mean, however, that it is not important to understand how you can lessen the impact of capital gains tax with a little forward planning.

At present, for assets acquired after 21 September 1999 and held for more than 12 months, capital gains tax is paid on half of the actual gain (that is, gain made less buying and selling costs), and as it is essentially tacked onto the top of your other income, the rate is your highest marginal rate. 

Capital gains tax (CGT) is included on your annual income tax return. It is not a separate tax, merely a component of your income tax. You are taxed on your net capital gain at your marginal tax rate.

Your net capital gain is:

your total capital gains for the year less your total capital losses for the year and any unapplied net capital losses from earlier years less any CGT discount and small business CGT concessions to which you are entitled.

You do not pay capital gains tax on your principal place of residence.

One big misconception with Capital Gains Tax is that it is paid at the top marginal tax rate. This is incorrect.

Any capital gain made is added to your other income to give you your taxable income and then taxed at your marginal rate which may not necessarily be the top tax rate. If the gain is in a super fund then the tax rate is 10%, capital gains inside companies are not subject to any discounting.

Another misconception is that in the event a loss is made, that loss can help reduce your taxable income as a negatively geared property would. This is also incorrect. A capital loss can only be offset against a capital gain.

Documents

When determining a capital gain or loss it is important to keep all documentation relating to the purchase or sale of the asset and all expenses associated with the purchase or sale as these may form part of your cost base reducing any capital gain.

The two important points to note in calculating a capital gain are as follows:

1. The date of acquisition and sale is that on the purchase and sale contract not the date of settlement.

2. In order to be eligible for the 50% discount method you must own the asset for a full year excluding the purchase and sale dates and it must not be in a company name, it must belong to either an individual, a complying superannuation entity or a trust.

Sale of Property
Where property is concerned, you will incur capital gains tax when:
•    a property you own is lost or destroyed (the destruction may be voluntary or involuntary)
•    you give a property away
•    you stop being an Australian resident
•    you enter into a conservation covenant, or
•    you sell a property for more than you paid.

Rules if You Inherit a Property
If you inherited a property before 20 September 1985 and later sell it, you can disregard any capital gain or capital loss on that property. However, if you made any ‘major capital improvements’ to the property after 20 September 1985 and it wasn’t your main residence, you have to calculate the capital gain on that part of the property when you sell it.

If you inherit a property from a person who dies after 20 September 1985 but who acquired the property before 20 September 1985, you will get a full exemption if settlement of the contract to sell the property happens within two years of the person’s death.

If the property was purchased by the deceased on or after 20 September 1985, you must consider the use of the property at the time of their death. You are entitled to a full exemption if you became the owner of the property after 20 August 1996, it was the deceased’s main residence just before they died, it was not being used by them to produce income at that time, and either;

• settlement of the contract to sell the property happened within two years of their death, or
• it was your main residence (or the main residence of the deceased's spouse or an individual who had a right to occupy it under the will) and it was not used to produce income from their time of death until settlement of the contract to sell the property.

If you became the owner before 20 August 1996, you will only get a full exemption if it was the deceased's main residence (and was not being used to produce income) during all the period they owned it and, from the time of their death until you sold it, it was your main residence (or the main residence of the deceased's spouse or an individual who had a right to occupy it under the will). If all of these conditions are not met you may be eligible for a part exemption.

Small Business Roll Over Relief
To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the ‘basic conditions’.

Each concession also has further requirements that you must satisfy for the concession to apply (except for the small business 50% active asset reduction which applies if the basic conditions are satisfied).
The major basic conditions are in the form of three tests that must be satisfied:

  • the maximum net asset value test which sets a $5 million limit on the net value of assets that you and certain related entities can own
  • the active asset test, and
  • if the CGT asset is a share in a company or interest in a trust:

        o the controlling individual test, and

        o the individual claiming the concession must be a CGT concession stakeholder in the company or trust.

Once you have met these conditions you are able to reduce your capital gains tax to nil, note however to do this you will need to roll some of the money into Superannuation.

If selling your small business you should seek advice on the above issue before you sign a contract. There are also provisions to roll the capital gain into another business within a 2 year period.

Taking Profits
Capital Gains Tax is a part of doing business and making money, you should also consider your Capital Gains Tax position prior to selling an asset which has a capital gain, however, I do advise caution that you do not make it an over riding factor in deciding to take the gain or not.

The main influence on taking profits on any asset should be the future income and growth of that asset compared to alternative assets. A good way to measure this is to compare the return on the asset to that of cash or what we consider the risk free rate.

Example:
You have an investment property which is positively geared and worth $350,000. You are receiving $350 pw or $18,200 per annum, costs associated with the property are rates, insurance, repairs and agent fees total $4,200. Net return is $14,000 or 4%pa.

Compare this with the term deposit rate of 6%, for this investment to be worth holding it need to pay more than the cash rate. As such your property will need to at least have annual growth of 5% (2% to equal the cash rates and 3% to cover inflation) to be worth holding. Given the high risk level of property verse cash you should really be looking for an 8% return.

If the asset is not going to produce at least a 7% pa net return in the next 5-10 years you are better off in cash or another higher return asset. 

For more information on Capital Gains Tax give us a call on 07 4771 4577.