If you are an investor who is just starting out or you have been investing for quite some time now, you must have come across a term capital gains tax (CGT). It is an unavoidable expense that most investors have to pay during their investment journey.
Capital gains tax or CGT is not a separate tax, unlike some people initially believed it to be. In the income tax return, it is added as a person’s taxable income. Still, there are a couple of things that may be a little complex for a lot of people.
To help you understand what capital gains tax is and when you have to pay it, here is an in-depth guide.
Capital gains tax
What is capital gains tax? When you purchase property, shares or any other assets (subject to the CGT rules) for one price and you sell them for another amount (or price), the difference between the two numbers, i.e., the purchasing and the selling price, is what is termed as capital gain or a capital loss.
If you sold your CGT asset for more than the amount you bought it for, it is a capital gain. However, if you sold it for less, then you made a capital loss.
Capital gains are added to an individual’s assessable income, and the marginal tax rate is used to calculate the tax to be paid. As a result, the tax an investor has to pay may increase, and the net return or profit from investing may reduce significantly.
Capital gains tax (CGT) events
A CGT event is when a person makes a capital gain or capital loss, mainly by selling the CGT asset. Here are some examples of the same:
- Selling or giving an asset to somebody
- The asset is lost or destroyed
- Your owned shares are surrendered, cancelled or redeemed
- You are no longer an Australian resident
- Getting a payment from the company, other than shareholder dividend.
CGT Discount
The ATO or the Australian taxation office offers a CGT discount that may allow you to reduce your capital gain by 50%. For this, you must fulfil the following two conditions:
- You kept the asset for at least a year (12 months) before the CGT event.
- You are considered an Australian resident for tax purposes.
To calculate the duration of the acquisition of assets held, you have to exclude the day you acquired it along with the day when the CGT event occurred. This way, you can determine if you owned an asset for 12 months before the CGT event.
Indexation method
If you have acquired the asset before 21 September 1999 and owned it for a year (12 months) or more, the indexation method is available for you to use. Also, you should not be a company to use this method.
The indexation method applies a multiple that accounts for inflation on the cost base of the assets (till September 1999).
This method is preferred by investors who have been carrying forward capital losses for the assets held before 1999. If you do not apply this method while being eligible, the discount method will apply.
‘Other method’ is also used to calculate capital gains. It is applicable if the asset was held for less than 12 months and was sold within this period. In such a case, the individual is not eligible for the capital discount or indexation method.
How much capital gains tax do I have to pay?
The amount you will have to pay will depend upon some factors. These factors include the duration you have held the asset, your marginal tax rate, and if you have made capital losses.
Your marginal tax rate is one of the most important factors, as the capital gain is added to the assessable income in a person’s tax return for that specific financial year. Depending on how long you hold your assets, you will get to know if you are eligible for a 50% discount.
When do you not have to pay capital gains tax?
Are there any specific conditions under which a person may not pay capital gains tax? Yes, if they made a net capital loss in that income year. It is worth noting that the net capital loss cannot offset tax on other income.
However, it can be carried forward so as to offset capital gains in future income years. Along with this, some events and assets are also exempt from CGT.
CGT Assets and Exemptions
Not every asset is subject to capital gains tax. Here is the list to help you figure out if you have to pay capital gains tax on the assets you own.
Asset or property acquired before 20 September 1985
If you have acquired an asset before 20 September 1985, it will be exempt from CGT. However, any additions or improvements to that property following this date may be subject to CGT.
Your home
What about your main residence? Your main residence is generally exempt from capital gains tax. However, this tax may apply in the following scenarios:
- You rent out a part of your home (or the residential property).
- You use this space for business.
- It is built on more than 2 hectares of land.
- If you are a foreign resident and don’t satisfy the life events test requirements when the CGT event takes place, the tax may apply.
Granny flat arrangements
CGT or capital gains tax does not apply to an eligible granny flat arrangement when it is created, varied or even terminated.
Depreciating assets
If any depreciating assets are used for taxable purposes only, CGT will not be applied. Such assets may include business equipment and items in any of the rental properties. Any gains or losses made on depreciating assets are considered assessable income or can be claimed as deductions.
But, for depreciating assets used for private purposes, capital gains tax may apply.
Now, moving on to the ones that are subject to CGT.
Real estate
You will have to pay capital gains tax for the following:
- Vacant land
- Rental Properties
- Holiday houses
- Hobby farms
- Business premises
In case you acquired these before 20 September 1985 and made some additions and improvements after this date, they may be subject to capital gains tax.
Shares
Now, this is a common worry of almost every new investor. The Australian taxation office states that selling shares is considered a CGT event and, thus, will be subject to capital gains tax. The same applies to units or similar investments.
It includes selling or receiving a distribution (aside from a dividend) from a managed fund. However, if a person trades in shares as a business, then the business will be taxed. As a result, capital gains tax is not applicable.
How much capital gains tax do you pay on shares?
There is no fixed amount of tax you have to pay while selling shares. Just like other assets, you need to consider a couple of things. To name a few, you have to consider the duration you held those shares and if you made capital gains or capital losses on the investment.
Cryptocurrency
CGT applies when crypto assets are disposed of. However, if this investment is a personal use asset, the capital losses or capital gains from disposing of the assets may not be subject to CGT.
Personal use assets
If the money you spend to acquire the personal use asset exceeds $10,000, a capital gain on the asset is subject to capital gains tax. However, the capital losses on these assets are completely ignored, i.e., you can’t use these losses to reduce the capital gain on any other asset.
Collectables
You will not have to pay tax on a collectable in the following cases:
- Its cost is $500 or less
- You acquired a share in it when its market value was $500 or less, or before 16 December 1995 for $500 or less.
In other cases, you will have to pay capital gains tax.
Keep in mind that you can only deduct capital losses on collectables against the capital gains from other collectables, not against other capital gains.
If you need professional advice on your capital gains tax, reach out to Clear Tax accountants.
Disclaimer: The information on this website is for general purposes only and should not be relied upon for making legal or other decisions. The advice provided in this article is general in nature and is not subject to the personal financial situation and needs of any individual. Clear Tax tries to keep the information accurate and up-to-date; however, you should bear in mind with changing circumstances, the accuracy and reliability of the information will not necessarily remain the same. The information is by no means a substitute for financial advice.
