How capital gains tax works when selling a property

• The basics of capital gains tax law.
• How to calculate capital gains on property sales.
• Capital gains tax exemptions and discounts.

Selling a property for substantially more than you bought it is a great way to build wealth. However, that profit may be taxable income. This is known as capital gains tax (CGT). This article will help you calculate your amount of CGT and how to minimise it.

CGT is something every investment property owner will have to face at some point. It can even influence when you decide to sell your property.

If you remove the ambiguity and confusion from the concept, you can make the sale of your property as profitable as possible. Read on to demystify this specific form of tax.

What is the CGT on property sales?

‘Capital gains’ refers to the profit you make from the sale of an asset. It is an appreciation of value over the period of time you’ve owned the asset.

Capital gains tax is a tax that you have to pay based on the profit you’ve made from selling this asset. For property, the law states that property other than your main residence is subject to capital gains tax.

These property types include:

• rental properties;
• holiday homes;
• hobby farms;
• vacant land;
• business premises.

How is capital gains tax calculated?

To calculate capital gains tax you will firstly need the initial amount you paid for the property. Then you’ll need to calculate the total costs associated with buying and selling the property. Incidental costs should be included in this calculation too. These include fees such as advertising costs, title transfer costs, valuations, and real estate agent and conveyancer fees.

Once you have these figures, you can use one of two methods to calculate CGT: the indexation method or the discount method.

The discount method

You could use this method if you’ve held the asset for 12 months or more.

1. Subtract the total property cost above from the value you now sold the property for.
2. Apply the discounts you are eligible for (discussed in the next section).
3. The resulting figure is your net capital gain. This figure is what you will need to declare as taxable income.

For instance, if Amy buys a house for $200,000 and sells it for $350,000 she has a net gain of $150,000. She calculates the ownership/sales/advertising/agent/stamp duty costs to come to $80,000.

This means her capital gain is $70,000. Since she has owned the property for more than 12 months, she gets a 50% discount. This means she will add $35,000 to her taxable income for that year.

If Amy shared ownership of the house with her partner Sam, they would each declare 50% of the calculated gain.

The indexation method

You could use this method if you bought the property before 21 September 1999.

This method uses the consumer price index (CPI). If you’ve owned your property for many years, the CPI during the time of purchase may be very different from the CPI at the time of sale.

Firstly you’ll need both of these values. Divide the current CPI by the one at the time of purchase, using a CPI chart provided by the ATO, and multiply it by the initial cost of the property.

This is the inflation-adjusted purchase price that can be subtracted from the sale price along with the additional costs listed above.

Discounts and exemptions

A residence you own and live in — your house or apartment — is exempt from CGT. However, there are some caveats. You may have to pay CGT on your home if you rent out a portion of it, use it for your business, or if the land is a certain size (over 2 hectares).

If you are an Australian resident and have owned the property for longer than 12 months, you get a 50% discount on your CGT. Superannuation funds can reduce their CGT by 33.3%.

If you provide affordable rental housing, you can get an extra 10% discount plus the 50% discount mentioned above.

How does CGT affect property owners in Australia?

The main way CGT affects property owners is usually in how long they decide to retain the property. Many owners may opt to keep the property longer to gain discounts.

In another way, it will adversely affect the seller as the increased value of the property might have been a long-term scheme to build wealth. Now a major portion of the wealth generation is counted as taxable income.

What does the ATO want people to do?

The ATO mainly wants you to declare your full taxable income. This means keeping track of your assets so that you can calculate your own capital gains and their discounts (if applicable). It involves:

• Recording exactly when you acquire an appreciating asset (shares, real estate property, cryptocurrency, etc.).
• Recording the ownership and value at the time of acquisition.
• Maintaining records in English.
• Keeping all receipts of purchase as well as of repairs/modifications.

If you trade stocks and/or cryptocurrency, check if these online platforms keep track of your transaction history. If you have a number of trading accounts open — currently or in the past — then you'll probably need something more comprehensive than what a spreadsheet can do.

Since tracking investments over time can be a complex and time-consuming endeavour, it may be easier to use an investment portfolio management tool such as Sharesight. Crypto investments can be even more complex to record, especially if you have more than one wallet. Recently, a number of services have been developed to manage and calculate your crypto CGT.

After you complete your calculations you are required to complete the capital gains section on your tax return. Remember that it is different for individuals and other entities (companies, trusts, and superannuation funds).

FAQs

When is a capital gain triggered? Only when you sell? Or what if you buy a house and don’t sell?

When you sell an asset that has appreciated in value and is subject to CGT, it is referred to as a CGT event. If there is a contract drawn up to define the sale, the CGT event happens when you make the sale, not at the time of settlement.

This will define the year in which you will have to declare your capital gain as taxable income. Remember that CGT is only applied to assets you sell and make a profit from. If you own a house and have not sold it, it will not yet be subject to CGT.

How long must you live in a house to avoid capital gains tax?

If you live in the house as your primary residence, you are — with some conditions — exempt from CGT when you sell it. You will need to prove that you’ve lived in the home for at least six months.

Is there anything you can do to minimise CGT on property?

You can be exempt from CGT if the property is your main residence. If you have owned a property — that you don’t live in — for more than 12 months, you can get a 50% discount on the CGT.

If you provide affordable rental accommodation this can become a 60% discount. You can also opt to time your property sale for when you know you are going to make a lower income for that financial year because you will pay a lower marginal tax rate if your entire income is lower.

What do I have to do if my house devalues?

This may result in a capital loss if you decide to sell. You can still time this effectively and use it to decrease the tax on the gains on other investments, or carry forward an unused capital loss to a later income year.

How much trouble can you get in if you fail to comply?

If you fail to meet your tax obligations there may be penalties, for example, for including false information or filing a tax return late. In most cases, the penalty is a fee that is calculated based on past behaviour and the taxable amount avoided.