Learning the mechanics behind the capital gains tax (CGT) on property best begins with the definition of a capital gain.
Simply put, a capital gain is a profit earned if you sell an asset, such as real estate property or shares of stock. Profits derived from the sale of bonds, jewellery, and coin collections are also capital gains.
The British term for this profit is “chargeable gain.” It refers to the increase in the value of an asset in the time span between its purchase and sale. This chargeable gain, as the term implies, becomes subject to Capital Gains Tax.
What is capital gains tax in Australia?
A CGT in Australia is added to your taxable income in the year that you completed the sale of an asset.
The Australian government began imposing CGT in 1985 as part of its tax reform program. The main reason for this tax was to prevent revenue loss from taxpayers’ conversion of income to capital which enjoys tax-free status.
Overall, the Australian tax reform sought to broaden the country’s income tax base by addressing some tax gaps. By filling these gaps, the government hoped to stem the growth of tax evasion and tax avoidance.
How is the capital gains tax rate calculated?
The initial step towards computing the CGT on your asset sale is establishing its cost base. This amount mainly includes the price you paid on the asset. It also carries all the transfer costs of the asset’s purchase and sale including their incidental expenses.
The transfer costs included in the cost base are the following:
- Borrowing costs, such as mortgage fee
- Advertising expenses on sale or purchase
- Valuation and termination fees
- Stamp duty on sale/purchase documentation
- Professional fees (for agents, brokers, etc.)
After getting your cost base, you can choose from two methods for your capital gains calculation. One of these choices is the discount method wherein you follow these steps:
- Deduct the cost base from the sale price to get your gross capital proceeds.
- Subtract from the gross capital proceeds any eligible capital costs.
- Apply on the resulting amount the eligible discounts, which are as follows:
- 50% discount for businesses or individuals who are Australian residents that held the asset for more than 12 months
- 33.33% discount for super funds and eligible life insurance companies
CGT computation indexed to inflation
The other choice in CGT calculation is the indexation method, which is tied to the consumer price index (CPI). It applies to assets acquired before September 21, 1999, and held for 12 months or more before the sale. This method relies on an inflation-adjusted cost base for the CGT calculation.
The CPI is used to compute an indexation factor to determine your cost base. First, you will get the CPI (historical database here) of the quarter that you sold the asset and divide it with the quarterly CPI when you bought the asset. Then, you will multiply the resulting indexation factor (rounded out up to three decimal points) with your original asset purchase price to get your inflation-adjusted cost base.
Finally, you will subtract this cost base from your asset’s selling price. The result derived is the capital gain to be added to your taxable income.
Reducing the amount of capital gains tax on property you pay
Thorough record-keeping can help you reduce the CGT you pay. Keep all the relevant receipts related to your asset.
This is important to document all the expenses you incurred in the purchase of a property and its improvement. The receipts of these expenses will help you prove a higher cost base and a lower capital gain for tax assessment.
CGT exemption on residential property sale
You not only can reduce CGT payment but avoid it altogether if the asset sale involves a residential property.
This CGT exemption applies if the asset you sold is your primary residence. For this exemption, you have to prove having lived in this residence at least 6 months after your purchase. The criteria for proving this include:
- You live with your family in the residence.
- You have your personal belongings in it.
- The residence serves as your mailing address.
- The electoral roll lists it as your address.
- Utility connections, such as power, gas, and phone.
Seeking ways to trim or avoid CGT payment is but one of the things to consider when selling an asset. Register on Soho to learn more practical tips, especially when you’re selling a real estate property.
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