Understanding capital gains tax
The ‘right’ time to sell your investment property really depends on your situation. Are you property flipping? Retiring? How about consolidating your debt? When it comes to property investment, it’s essential that you conduct your research at every stage of the journey. First-time investors should be across the basics of capital gains tax to put together a long-term strategy in line with their objectives.
In this blog, we look at the basics of understanding capital gains tax, your motive for selling and potential exemptions and ways to reduce your capital gains tax.
Capital gains 101
Put simply, capital gains are the difference between what a capital asset costs you and what you will receive when you sell the asset.
Capital asset refers to real estate, cryptocurrency, or shares. It does not include your primary residence, car, and belongings.
You are expected to pay tax on your capital gains and although it’s referred to as ‘capital gains tax,’ it’s actually a part of your annual income tax.
Capital gains tax is only payable in the financial year your purchase or sell your investment so if you have a long-term wealth strategy, you likely won’t pay capital gains tax for some time.
What’s your motive?
If you’re considering selling an investment property you need to think about your motive – the reason why you think it’s time to sell up.
Future Advisory Director, Jason Robinson, advises it’s essential for investors to, “begin with the end in mind.” While he knows not everyone understands the complexities of tax law, he does stress that “understanding when you sell an asset such as real estate, you are required to pay capital gains tax on the profit you make from the asset – the difference in value from when you bought the asset to the value when you sold it. This can help you to develop a strategy or determine whose name your property should be in.”
We look at some of the common motivations you may have for selling your property below:
You’re planning to retire
If you are planning to retire you may be planning to free up your capital by selling an investment property. In some instances, you can save tax by adding some of the proceeds to your super fund. If you’re under 65, you can make after-tax contributions of $300,000 to your superannuation fund over three years.
If you sell your property after you retire, keep in mind that it may impact your age pension entitlements.
Bad return on investment (ROI)
Measured by yield and capital growth, it’s important to regularly evaluate the ROI your investments provide.
When you consider the rental yield in comparison to your mortgage repayments, you will be able to determine whether your investment is negatively geared, which means the investment is costing you more than you earn.
While this might sound like a bad thing, it’s not necessarily. You will most likely be able to claim these expenses on your income tax to reduce your overall tax bill. It can also provide investors to invest in markets with higher growth and capital gains potential.
When it comes down to it, it’s still a cost and a financial loss, it’s something you need to consider as part of your long-term wealth strategy. If the market is stagnant or at a standstill, are you prepared to sit on the property to see if the market increases?
You have found a better opportunity
While it’s rare to sell one investment property to purchase another, it’s not unheard of. If your current property isn’t experiencing the growth you expect, and you’ve found a ‘sure-thing,’ make sure you do sufficient research first.
You are property flipping
If you’re property flipping, keep in mind the 12-month rule. Essentially, if you own the property for more than 12-months, you’re entitled to a 50% discount on your capital gains tax.
This discount is a government-led incentive to encourage people to own their investment properties for longer as it means people have available rental accommodation for longer, too.
Jason adds, “If you renovate your investment property and then decide to hold on to it for over 12 months before selling, you will ensure you lock in the 50 per cent discount. This means you’ll have a considerable tax savings. However, everyone’s circumstances differ and if you find yourself needing to sell in less than 12 months it is worth seeking independent financial advice beforehand.”
Can you tell me about capital gains tax exemptions?
Well, that’s a good question and there are a few ways to benefit.
Six year rule
If you live in your investment property immediately after purchase for at least 12 months and it then becomes a rental property, you can claim an exemption on capital gains tax for a period of up to six years.
50 per cent rule
As mentioned earlier, if you own your investment for more than 12 months, you are entitled to a 50 per cent discount on your capital gains tax.
Using a Self-Managed Super Fund to purchase property
If you have an SMSF, you may be able to purchase an investment property through your superannuation to avoid or minimise your capital gains tax.
You’ve previously made a capital loss
If you have previously had a capital loss on the property, you can potentially lessen the capital gains tax by carrying the losses over the gains you made in that year. For example, if you made a capital loss of $45,000 last year and a $75,000 capital gain this year, your capital gains tax is only charged on the difference of $30,000.
If you’re selling your investment property and looking to reduce tax, Jason says the number one thing to do is to keep your records.
“It blows my mind when it comes time to sell a property and often people can’t find some of their purchase documents and records as well as ongoing costs incurred on the property that may not have been claimed year to year on their tax returns. The best way to legally reduce your CGT is to be prepared, keep accurate records, and have a great team of qualified advisors around you to help with the strategy from the start,” he shares.
In conclusion, as with most areas of property investment, there is a range of variables and deliberations to consider if you’re planning on selling an investment property. The ‘right’ time can vary significantly from one person to the next so the best thing to do is seek professional advice. To book a free meeting with one of the Inovayt Financial Advisor team.