Initially, capital gains tax might seem intimidating, but if you edge a little closer, you’ll see it’s not nearly as complicated as you thought.
A capital gains tax is a levy you pay calculated based on the difference between what it cost you to acquire an asset and what you received when you sold it.
Capital gains tax applies to many types of assets acquired after 1985, except primary residences, but most commonly applies to real estate, shares, business investments, and personal use assets above a specific value. Some exemptions do apply.
When you make capital gains, the net proceeds are added to your total assessable income and could significantly increase the tax you need to pay when you complete your tax return.
An asset sold for less than what it was initially purchased for does not earn capital gains tax, known as a capital loss. A capital loss cannot be used to offset your assessable income but can be used to reduce future capital gains.
How is Capital Gains Tax Calculated?
Capital gains tax is calculated using three primary methods:
CGT discount method
Indexation method
The “other method.”
CGT discount method
You can apply this method if you hold the asset for more than 12 months, and you are eligible for 50% off. However, this discount isn’t available for foreign residents or companies. A 33.33% discount is available to eligible super funds and life insurance companies.
To calculate capital gains tax, subtract your cost base from your capital proceeds, deduct any capital losses, and apply the applicable discount percentage:
Capital Gains Calculation
Asset Sale Price – Cost Base = Capital Proceeds
Capital Gains Discount Calculation for Individuals
Capital Proceeds x 50% = Capital Gain
Indexation Method
Generally, the indexation method applies to assets acquired and held for an extended period.
Therefore, inflation will affect the asset’s cost base in a material way. To be able to use the indexation method, the purchase must be acquired before 11.45 am (ACT time) on 21 September 1999 and held for 12 months or more before the relevant CGT event.
The Consumer Price Index (CPI) calculates an indexation factor for each element of your cost base. The indexation factor is based on the following:
Calculation of Indexation Factor
CPI for Quarter of CGT Event ÷ CPI for Quarter when Expenditure Occurred = Indexation Factor
Capital Gains Indexation Calculation for Individuals
Capital Proceeds x Indexation Factor = Capital Gain
Other Method
The ATO calls this the ‘other’ method for unknown reasons, but it is used when eligibility requirements for the discount or indexation methods do not apply. As a result, you cannot receive any discount on capital gains if your assets are sold within 12 months of acquiring them. Therefore, this method calculates capital gains in the following way:
Asset Sale Price – Cost Base = Capital Proceeds
Inherited property and CGT
The CGT is not applicable when an inherited property is sold within two years of a deceased person’s passing as long as it was either purchased before September 1985 and was not rented at the time of the deceased’s death or just before.
This two-year period corresponds to when a person dies and when the sale contract is settled, not exchanged. If you wish to extend this two-year period, you can apply to the ATO.
In addition, special tax rules may apply to properties purchased before 20 September 1985 that were not the deceased’s primary residence. It’s important to speak to your accountant about your particular situation, as it may result in a full or partial exemption from CGT.
A two-year deadline has passed.
Unless your inherited property becomes your principal residence, you generally will have to pay capital gains tax on the capital gain if you sell it after the two-year exemption period has expired.
Your capital gains tax is based on the increase in your property’s value from the deceased’s death until the sale date.
In calculating capital gains on inherited property assets, the sale price is deducted from the asset’s cost base. Generally, the cost base is the amount paid for the asset. If the property was acquired before 20 September 1985, the cost base may be equal to the asset’s market value at the time of death.
In the meantime, keep records of the following:
-relevant costs incurred by you, the previous owner and the trustee or executor
-the market value of the dwelling at the time the deceased died.
If the executor or trustee has a record of a market valuation, get a copy of the valuation report.
Keeping property records
You should keep records of the following information about your property:
Acquisition of the property and related expenses, such as
-purchase contract
-stamp duty
-settlement statement
-legal fees
-survey and valuation fees
2. Expenses associated with disposing of property, such as
-the sale contract
-sale settlement statement
-legal fees
-sales commission
3. The costs of owning the property, such as maintenance and repairs
-interest
-rates
-land taxes
– insurance premiums
-the cost of repairs
4. capital expenditure on improvements, such as
-extensions or additions.
It is your responsibility to keep records of the property’s purchase, ownership, and sale for five years after it has been disposed of.
If you acquired your property before 20 September 1985, it is exempt from capital gains tax. If you later add a capital improvement to the property, you will need to keep records for CGT purposes.
For income tax purposes, you must keep records of any property income, such as rent.
If you rent out part of your home or run a business from home
It is essential to keep all records if circumstances change and your primary residence (home) is no longer exempt from CGT.
Keep records of:
- expenses during the time you produced income
- the proportion of the property used to produce income.
In the event of the first time your home is used to generate income after 20 August 1996, you need a record of the home’s market value at that time.
The market value of an asset is the estimate of its monetary value on the open market at a given moment.
-the most valuable use of the asset (which may be different to how it is currently used)
-the amount that a willing buyer and seller agree to in an arm’s length transaction.
An accountant can significantly help reduce capital gains tax by relying on their expertise in navigating more complicated situations.