Capital gains tax is perhaps one of the most misunderstood taxes, but it is also one that can have major impacts on the efficiency of your investment plans. The quick guide below will help you get to grips with the basics of how it may apply to you.
As always, it is essential to consult a qualified tax adviser to obtain complete advice on your tax situation and to speak to a financial planner to help form an investment strategy to take full advantage of your tax position.
What is capital gains tax?
Capital gains tax relates to the gains or losses you make when you sell certain types of capital assets. The difference between the purchase cost and sale cost of the asset will determine whether there is a capital loss or gain. This tax may apply to any asset purchased after 20 September 1985, which is when the tax was first introduced.
Assets purchased for personal use, such as your home, car and furniture, are generally exempt from capital gains tax, but assets purchased for investment purposes, such as an investment property or shares, may incur the tax.
How capital gains tax is applied
Realised capital gains are actually treated as income in the tax year in which the gain was made. Gains on the sale of a non-exempt asset must be reported in your income tax return and the capital gain is added to your income and taxed at your marginal rate.
However, if the asset has been held for more than a year, then a capital gains tax discount will apply and only half the capital gain is taxed.
If you incur a capital loss on the sale of an asset you may also be able to apply that loss against any capital gains you have made on the sale of other assets, thereby reducing your tax liability.
Capital losses can be carried forward
Even if you don’t have any capital gains to report in a particular tax year, any capital losses you incur in that year should always be reported on your tax return because they can be applied against capital gains in future years.
How are managed fund investments treated?
Managed fund investments generate returns based on dividends and capital gains on the assets they invest in. If you own units in a managed fund then any capital gains made within the fund need to be taken into account in your tax return.
Fortunately, most managed funds will provide you with a statement which details any net capital gains or losses that apply to your stake in that managed fund, so you can use that information in preparing your tax return.
Capital gains may also apply if you switch from one fund to another, so consult your financial planner to discuss the ramifications if you intend to do this.
It’s all in the timing
Timing the disposal of an asset can be critical if you're trying to minimise your capital gains tax liability. For example, if you're approaching June 30 and you want to sell an asset, it may be wise to defer the sale until after June 30.
This is especially the case if you're expecting your income in the new tax year to be lower, perhaps due to retirement or taking unpaid leave. The lower income may put you in a lower tax bracket, thereby reducing the amount of capital gains tax paid on that asset sale.
Capital gains tax on property
Capital gains tax does not apply to your primary residence. Some people see this tax benefit as being a good reason to put spare funds into extra mortgage repayments or renovations on the family home. This can reduce the diversity and liquidity of your investment portfolio so it's best to consult a financial planner about using this as an investment strategy.
If you have an investment property, your capital gain (or loss) will be based on proceeds from the sale of the property less the purchase cost, and any other costs associated with buying, renovating and selling.
The capital gains discount described earlier will also apply if you sell the property more than a year after purchase. However, it is vital to note that the sale date is based on the date of the contract of sale and not on the settlement date.
What if you inherit an asset?
If you inherit an asset from a deceased estate you do not incur any capital gains tax liability until you later dispose of the asset. Things can get a bit more complicated when it comes to an inherited home. The amount of capital gains tax will depend on a number of factors, such as:
- Whether the deceased person acquired the dwelling on or after 20 September 1985
- The amount of time between the time you inherit the dwelling and the time you sell it
- If it was the deceased person’s main residence or not
These complexities make it advisable to seek some professional advice from your legal adviser and financial planner to assess how inherited assets may be best integrated into your investment strategy.
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