How To Reduce Capital Gains Tax When Selling An Investment Property

If you're like most people, you probably have at least one investment property. And if you're like most people, you're also looking for ways to reduce your capital gains tax liability when selling it.

You may be wondering how to reduce capital gains tax when selling an investment property. Thankfully, you can do a few things to help minimise the amount of taxes you'll have to pay on your profits. This blog post will discuss some of the most effective methods for reducing capital gains tax on investment property sales.

Fortunately, there are a number of things you can do to help minimise the amount of taxes you pay on your profits. You can keep more of your hard-earned money in your pocket by following these tips! For example, when you sell an investment property, you are required to pay taxes on the profits you make. However, there are ways you can reduce the amount of tax you owe.

How To Stay Out Of Trouble With The Capital Gains Tax (CGT) When Selling Your Home

If you have enough information and put some effort into your strategy, you may be able to eliminate the need to pay any capital gains tax at all. Alternatively, you may be able to significantly lower the amount of tax that you are required to pay.

What Is Capital Gains Tax

For those who are unfamiliar with the term, "capital gains tax" (CGT) refers to the charge that you pay on the capital gain that you make on the sale of that asset.

The difference between the amount you spent for an item and how much it ultimately sold for is the amount of a capital gain (or loss), respectively (less any fees incurred during the purchase). A capital gain is the profit you make when you sell an asset for more than you paid for it initially. A capital loss is what happens when you sell an asset for less than you paid for it.

This guide will offer you with some useful information to get you started, and while it is always preferable to obtain professional counsel on how the law pertains to your individual case, it does provide some information that will get you started.

When you sell a capital item, such as a piece of property, cryptocurrencies, or shares in a company, you may either make a gain or a loss on the transaction. This refers to the amount of money you make from selling the asset minus the total amount of money you spent purchasing and maintaining the asset.

When you sell assets that you bought after September 20, 1985, you are only required to pay CGT if you have a capital gain from the sale of such assets (when CGT became effective). Your primary dwelling (main place of abode), your automobile, and your personal property are excluded from CGT.

On your annual tax return, you are required to report any gains or losses related to your investment in capital. Gains are counted as part of a person's taxable income and might result in an increase in the amount of tax that must be paid. A capital gain can be reduced by using a loss as a deduction.

How Much Is Capital Gains Tax?

When they sell an investment property, people who live in Australia are expected to pay a capital gains tax on the profit. Your total taxable income for the year will be increased by this amount. To illustrate, let's say that your annual pay is $70,000 and your capital gain is $40,000. This brings your total assessable income for the year to $110,000.

When you have established your income that is subject to assessment, the next step is to compute your CGT using the tax bracket that applies to you for that particular year. The next step is to look for additional information on resident tax rates on the website of the Australian Taxation Office (ATO). In addition to that, you can consult their guide for rates applicable to international residents of Australia.

If you find yourself in the highest tax category, you can be responsible for paying up to 45% of the gain on your home. Utilise the CGT calculator provided by the ATO to simplify the process of calculating the tax on capital gains.

When Must Capital Gains Tax Be Paid?

The capital gains tax is due at the same time that you file your tax return for the year in which you sold your property. Therefore, if you sell your property in September, you will be required to pay capital gains tax in July of the following year, which is when the financial year comes to a close.

Keep in mind that the "date of sale" refers to the day that you signed the contract to sell your property; it does not refer to the date that you decided to settle or move out of the property.

If a property is sold for more money than it was purchased for, then the seller is subject to capital gains tax (CGT). However, there are always going to be exceptions. For instance, the capital gains tax does not have to be paid if the property in question is a person's primary dwelling, sometimes known as their house.

If the property was purchased before September 20, 1985, there is another regular exception to the rule. It is important to keep in mind, however, that any significant additions or repairs performed after that date may be regarded as a separate asset under the legislation and, as a result, liable to CGT.

In the meanwhile, small business reductions on capital gains tax may also be applicable if the property is used in connection with a business and the taxpayer satisfies a number of requirements.

How Are Capital Gains Calculated On Property?

To rapidly determine the amount of capital gains you have accrued, simply subtract the purchase price of the property from its selling price. The difference is the amount of capital gains you have.

The sale price is subtracted from both the acquisition price and the costs associated with the transaction to arrive at the gross capital gain.

In most cases, a discount of fifty percent is applied to the gain realised from the sale of a property after it has been held for more than a year. However, organisations do not qualify for this reduction, nor do non-U.S. citizens who purchased their home after May 8, 2012; also, the discount for self-managed super funds is only one-third of the full amount.

According to Dixon, you need to include in your calculations for capital gains tax any other income you receive during the year in which you sell your home. This is because your marginal tax rate will determine how much capital gains tax you end up having to pay. This is due to the fact that the CGT is not truly a distinct tax but rather a component that falls under your income tax.

Use The Main Residence Exemption

If the home you are selling is your primary residence, any profit you make from the sale will not be subject to capital gains tax. However, if the residence has been used in any way to generate money, the exemption might not apply in its whole. In this scenario, some of the gain from the investment will be subject to income tax.

Use The Temporary Absence Rule

The temporary absence rule is essentially an extension of the main residence exception that applies in the event that you move out of your primary house.

If you initially acquire a property with the intention of using it as your primary residence but then decide to rent it out, you can continue to use the property as your primary residence indefinitely or for up to six years after you rent it out. In addition, if you move back into the rented property within the first six years, the period starts over and the property can be considered your primary residence for an additional six years.

Invest In Superannuation

Even though self-managed super funds are only eligible for a one-third discount on CGT, the basic tax rate for funds is only 15%, which means that the highest CGT rate is only 10%. Which is a rate that is lower than the marginal tax rate for the majority of people.

This applicable rate becomes null and void in the event that a member of a self-managed super fund begins drawing a full retirement pension from the assets of the fund.

Make Sure That You Time Your Gain Or Loss On Your Capital Investments Correctly

Consider the timing of when you make a capital gain or loss. This is a straightforward tactic for lowering your capital gains tax liability. For instance, if you anticipate that your income will be lower in the subsequent fiscal year, you have the option of delaying the sale of any assets until that time. As a result, your capital gains tax bill will be lower because your marginal tax rate would be lower.

Loss of timing might also be advantageous in some situations. An illustration of the scenario in which a person anticipates realising a capital gain from the sale of an asset while simultaneously holding shares that are now trading at an unrealised loss that is smaller than the anticipated capital gain. The individual can think about selling the shares before the transaction takes place in order to reduce the impact of the loss on their overall capital gain.

Consider Partial Exemptions

If you hold onto a property for more than a year, you will be eligible for a capital gains tax discount of fifty percent. If you move into a rental property, you may also be eligible for a partial exemption from CGT.

If you use your primary property as a place of business in addition to using it for personal purposes, you are eligible for a CGT reduction.

Investing in affordable housing, on the other hand, can result in a reduction of capital gains tax of up to sixty percent, provided that the property in question satisfies a number of requirements and that the rent is reduced.

You can subtract your capital losses from your capital gains, but you can't use your capital losses to reduce your regular income.

As always, though, you should make sure to get professional guidance in order to obtain the best possible conclusion for your particular circumstance.

Utilise Your Advantages As An Owner-Occupier

The asset might be considered your primary place of residence (PPOR) if you move in as soon as possible after purchasing it and make it your permanent home. Because of this, it is immune from CGT.

Take into consideration that you won't be able to carry out this action if you rented out the property in the past and then moved into it at a later time. However, you are eligible for a partial exemption that is proportional to the number of "years lived in" as opposed to the number of "years rented in" at the property.

Consider the following scenario: after renting out a house for three years, you ultimately decide to move in and make it your permanent residence for the next six years. After that, you sell the property and make a profit of $100,000 Australian Dollars. The amount that is subject to taxation for you will be $AUD33,333, which is equal to one-third of the amount that you earned. To put it another way, you are only subject to taxation for the three years out of the nine that you owned the house during which you rented it out.

Get The Property Reassessed Before Renting It Out

The difference between the ultimate sale price and the value of the property when it was rented can be used to determine the amount of capital gain that was realised. If you hire a certified valuer before you start renting it out, they will give you a new cost basis that you can use to figure out how much any future gains are worth.

Take this scenario as an example: you spend $150,000 AUD on a home and continue to reside there for the next decade. After this time period has passed, you will have the property revalued at $AUD450,000, and then you will begin renting it out. After another two years, you decide to sell the house for a total of $AUD480,000.

This indicates that you made a capital gain that is subject to taxation in the amount of $AUD30,000. However, when compared to the amount of your taxable income that would be generated if you were required to deduct the gain from the property's initial price of $AUD150,000 before it was revalued, this is a significant deduction.

On the other hand, if you sold the property for AUD420,000, you would have made a capital loss of AUD30,000. This is due to the fact that you sold the property at a price that was lower compared to its value before it was rented out. You are able to deduct this amount from any future or present gain on a capital investment. A year later, if you have a capital gain, you can utilise the loss to lower the amount of the gain. However, you are unable to deduct losses on investments or a net loss on investments from any other income you may have.

Use Exemptions Like The 6-Year Rule

If you rent out your property for a period of six years or less and do not treat another home as your primary residence, you may qualify for a complete exemption from paying capital gains tax on the sale of your property if you use this circumstance.

In spite of the fact that this is sometimes referred to as the "6-year rule," it does not actually refer to six calendar years. Instead, it simply relates to the period of time during which your property has a renter who is actively paying rent. You are still eligible for this exemption even if, for instance, you rented out a house for eight years but then it sat empty for a number of months that added up to two years.

Example: You spend $AUD500,000 on a home, move in right away, and then list the house as your principal place of residence (PPOR). After a period of one year, you decide to relocate outside of Australia and have the home reassessed at $AUD600,000. After an absence of eight years, you decide to go back to your hometown and sell the house for $900,000.

Your taxable gain is $AUD300,000 multiplied by 2/8 (because of the 6-year rule, you are only liable for the two years out of the eight years that it was rented, hence this is the formula for determining your taxable gain). Because you have owned the investment property for more than a year and a half, you are eligible for a further reduction in the amount of capital gains tax that you must pay. As a result, the amount of the taxable gain is reduced to $AUD 37,500.

If you fall into the third tax category, your effective tax rate (applied to the taxable gain of $AUD37,500) will be 37%. As a result, you made AUD $300,000, but the total amount of CGT that you owe for the two years out of eight in which you rented out the property is AUD $13,875.

When it comes to the sale of investment property, the objective is not only to understand how to avoid paying capital gains tax, but also to do so in a manner that is compliant with the law. You are legally able to achieve a considerable reduction in your capital gains tax with the help of the solutions on our list. Keep in mind that you are required to pay your dues at all times; however, this does not imply that you are required to pay more than what is appropriate.

Consider Partial Exemptions

If you hold onto a property for more than a year, you will be eligible for a capital gains tax discount of fifty percent. If you move into a rental property, you may also be eligible for a partial exemption from CGT.

If you use your primary property as a place of business in addition to using it for personal purposes, you are eligible for a CGT reduction.

Investing in affordable housing, on the other hand, can result in a reduction of capital gains tax of up to sixty percent, provided that the property in question satisfies a number of requirements and that the rent is reduced.

You can subtract your capital losses from your capital gains, but you can't use your capital losses to reduce your regular income.

As always, though, you should make sure to get professional guidance in order to obtain the best possible conclusion for your particular circumstance.

Use The Principle Place Of Residence Exemption

If you and your family have lived in a property since the time it was purchased, the property has not been used to generate any revenue, and the land it stands on is less than two hectares, you can normally expect to gain a full exemption from CGT when you sell the property.

In a broader sense, the ATO will consider a home to be your principal residence if it satisfies the following criteria; however, varying weight will be assigned to each factor based on the specifics of the individual case:

• You and your family make your home there.
• It is where you keep your own personal possessions.
• It is the location where your mail will be delivered.
• It is the address that is listed for you on the electoral roll.
• Connectivity is established for services including gas and power.

However, a property can keep its status as a main residence permanently provided that it is not used to generate money. This is true even if the owner moves out, updates their address on the electoral list, and moves their personal possessions to a new location. When you sell your primary house, you may be able to claim an exemption from the capital gains tax.

Inflate Your Expenses

Increasing the cost base of your property is one approach to lower the amount of money you have to pay in property taxes. Your total capital gain is calculated by taking the selling price and deducting the costs of purchasing, maintaining, and selling the property. The result is your capital gain.

The following are the components that the ATO identifies as constituting the cost base of a CGT asset:

• The money you paid for the asset.
• The incidental costs of acquiring the asset include stamp duty and valuation fees.
• The cost of owning the asset.
• Capital costs to increase the asset’s value.
• Capital costs of preserving or defending your title or rights to the asset.

Increasing the cost base can be done by including things like stamp duty, loan application fees, conveyancer’s fees and the cost of any renovations. Make sure to keep records of all your property-related expenses to assist with this.

Maintain Ownership of the Property for a Minimum of One Year

Any real estate that is bought and sold during the same year is subject to the maximum capital gains tax rate. However, if you keep a piece of real estate for more than a year before selling it, you have the option of reducing your capital gain by either using the CGT discount technique or the indexation method.

Your capital gain receives a discount of up to fifty percent when you use the CGT discount technique. Therefore, if a property sells for a price that is $200,000 higher than its cost basis, only half of that amount will be added to your taxable income. This amount is $100,000.

The indexation approach is a little bit more involved, and the only time you'll be able to utilise it is if you bought a home before September 21, 1999. Applying an indexation factor that is based on the CPI enables you to translate the original cost of a property into the current value of that property in today's money.

Is There Any Kind of Direct Exemption From the Capital Gains Tax That Can Be Obtained on a Property?

In a nutshell, the answer is yes; but, this must be qualified by the context. In order to qualify for CGT exemption, a property must serve as the owner's primary residence in the following ways:

• On your property there is a house, an apartment, or another type of dwelling.
• You have previous experience living at that residence.

When deciding whether or not a building is your primary residence, in addition to the following elements, you may also take into consideration the following:

• In the event that you and other members of your family live on the property.
• If the furniture and any other objects of a personal nature found within the residence belong to you.
• If the property also serves as your address for receiving mail.
• Providing that the property is listed as your primary residence on the voter registration database.
• You are the person responsible for paying the bills for the utilities connected to the property.

Regardless of the specifics of the situation, a vacant lot will not be eligible for this exception. It is also highly improbable that you will be granted the exemption if, during the time that you lived in the property, you were not considered to be an Australian resident for the purposes of taxation. This amendment was included in the budget for the 2017–18 fiscal year, and it took effect on May 9 of the same year. As a result, if you are a foreign resident and you previously held property prior to this date, you were still entitled to receive this exemption until the 30th of June, 2020. This exemption will no longer be available after that date.

There is also a period of time after moving into a new home that follows the purchase of a new property during which both the home you are moving from and the new home can be designated your main residence for the purposes of capital gains tax. The phrase "temporary absence rule" describes this particular regulation. In situations in which you intend to generate revenue from a property that has been inhabited in the past, this time may run for as long as six years.

Is It Possible To Avoid Paying Capital Gains Tax?

Talking to a tax accountant is the best way to ensure that you get the most accurate and up-to-date information regarding how to avoid paying capital gains tax in Australia. They will examine all of the possibilities and work with you to eliminate or reduce the amount of tax that you are responsible for paying. This includes determining if you are qualified to make the claim that the home you are selling is indeed your principal residence.

However, there are several things that you may do to reduce the amount of capital gains tax that you owe. Keep things straightforward by adhering to these three guidelines:

• If you keep any investment property for more than a year, you may be eligible for a deduction on your capital gain equal to half of that property's value.

• Keep careful records of every dollar you spend on the property, beginning with the day you buy it, so that you can reduce or eliminate any potential gain in the future.

• If you are planning to sell an investment property, the best time to do so is during a year with a low income. Because the tax on capital gains is calculated based on a percentage of your income, if you anticipate having a year in which your earnings will be lower than average, this could result in a reduction in the rate of the capital gains tax that you are required to pay.