Most of the time, your property is regarded as a capital asset. Therefore, it will be subject to capital gains tax. A capital gains tax, also known as CGT, is a tax imposed on the profits made from selling certain types of assets. It has a significant impact on the economy by curbing speculation and fostering investments, especially in the real estate industry.
The quickest way to calculate capital gains tax is by subtracting the original cost and related expenses of the asset from its selling price. When the remaining amount is greater than zero, you have a capital gain, and you pay tax on it at your marginal income tax rate. But there are ways to avoid capital gains tax. Here are some ways how you can prevent or reduce it.
- Make a note of the purchase date.
- Use the exemption for your primary residence.
- Use the rule of temporary absence.
- Make the most of your retirement savings.
- Boost your cost base.
- Keep the property for a minimum of 12 months.
- Sell during a year when your income is low.
- Invest in low-cost housing.
In the following section, we’ll go over each of them to find out how they avoid or minimize capital gains tax on your property sale.
1. Make a Note of the Purchase Date
Capital gains tax is implemented in almost every state, but at different points in time. In most cases, assets acquired before the implementation will not be liable for the tax. For instance, in Australia, the CGT start date or the capital gains tax was introduced on September 20, 1985. The assets acquired before this date are eligible for exemptions, meaning they are not subject to the capital gains tax. Thus, you should keep track of when you bought the asset to take advantage of this. However, it is also important to note that any losses cannot be used to lower your assessable income.
2. Use the Exemption for Your Primary Residence
If the property you are selling is your primary residence and does not generate income, any gains or profits from the sale will generally not be taxable. You can take full advantage of this benefit to avoid paying capital gains tax. There may be certain requirements depending on where you live. Generally in Australia, the ATO or Australian Taxation Office verifies whether your address is on the electoral roll or if it is where your mail is delivered. But again, this all depends on the situation. To know if you qualify for such an exemption, it’s best to check with your local authorities.
3. Use the Rule of Temporary Absence
If you no longer live in the property but rent it out to make money, you may still avoid or reduce the capital gains tax on the sale of it through the temporary absence rule. For a maximum period of six years, the Australian Taxation Office will continue to consider the property as your main residence. Even if you are not living there anymore.
In the event you move back in within the six years, then leave and rent the property once more, the rule will simply renew for another six years. However, make sure you do not claim any other property as your primary residence during the absence period. In any case, it completely depends on the rules and regulations of the area.
4. Make the Most of Your Retirement Savings
There are ways to use retirement programs to avoid capital gain tax. When you put money into these plans, your investment grows free from immediate taxation. You can also make purchases and sales through these accounts without being subject to capital gains taxes. These retirement plans may include 401(k), 403(b), and even traditional retirement accounts. Consider speaking with an expert to learn how you can take full advantage of your retirement savings to lower or avoid paying capital gains taxes.
5. Boost Your Cost Base
Cost base refers to the total amount you paid for an asset, including any other associated costs. Some of these expenses include stamp duties, real estate agent fees, and other expenses incurred to increase the value of the property. Typically, you subtract this figure from the selling price of the property to calculate your capital gain or loss. Hence, keep a record of all expenses associated with your property.
6. Keep the Property for a Minimum of 12 Months
You will pay full tax on the sale of a property when you sell it within the first year of purchase. Therefore, it would be best to hold onto a property for at least a year if you wish to reduce your overall capital gains tax. In Australia, there is a 50% discount for people who own an asset for 12 months or more. It may also be possible to receive other discounts based on certain circumstances, so inquire with the local authority to learn and take advantage of them.
7. Sell during a Year when Your Income is Low
Capital gains tax is triggered when you sell an asset. Therefore, to reduce capital gains tax, it makes sense to delay the sale of your property until next year, when your income is predicted to be lower. This will reduce your marginal tax rate, and your capital gains tax liability. While this requires some planning, it can save you more money if done correctly. This would also be helpful if your income goes up in future years for whatever reason as it may allow you to get a better price for the asset.
8. Invest in Low-Cost Housing
When building your rental property, consider using affordable yet quality materials. Since you may receive a discount for such properties depending on your location. In Australia, taxpayers can reduce their capital gains tax (CGT) by up to 10% on a sale of property that is used for affordable rental housing. However, there may be some requirements to qualify. One of which is that you should rent the property out to tenants with low or moderate incomes. It must also be at a lower rate than the private market.
When do You have to pay Capital Gains Tax on a Property?
You should only pay the capital gains tax after selling the property. This is because, in general, capital gains taxes are only due on sold assets and are calculated on the profit from the sale.
To illustrate, suppose John is planning to sell his property for $120,000 with a cost base of $80,000. The difference between the two is $40,000. This represents his profit or capital gain, on which the capital gains tax will be imposed. In short, this tax is only applicable to the profits made on the sale of property, not to losses, and especially not when the property is just held.
How are Capital Gains Calculated on Property?
There are several methods to perform a capital gains calculation. Perhaps the simplest way is to first figure out the difference between the cost base and your selling price. As previously mentioned, the cost base refers to the amount you pay for an asset, including any other additional expenses. A selling price, on the other hand, is the end price that you set for your property. If the difference between the cost base and the selling price is greater than zero, or when you make a profit from the sale, then you have made a capital gain.
How Much is Capital Gains Tax in Australia?
Tax rates on capital gains vary between companies and individuals. In most cases, companies do not get discounts and their taxable capital gains are subject to a 30% tax. For individuals, the rate will be the same as the income tax rate for the year. The amount of Capital Gains Tax is still determined by various factors. This includes your ownership period, tax payments, and whether you incurred capital losses.
Does CGT Apply if You Transfer or Gift a Property?
A capital gains tax applies when you transfer or gift a property to a family member or friend, but the amount is based solely on its market value. The giver is liable for this tax, whereas the recipient is not unless he later sells the property. In Australia, this is typically the case. It is important to note, however, that different CGT guidelines may apply in different places. There are a lot of things to know before gifting real estate. To be sure, check with the experts or local authorities beforehand.
Does CGT Apply on Inherited Properties?
In most cases, capital gains tax applies to inherited properties only when the recipient sells them later. This isn’t imposed if you simply receive and hold the asset. In Australia, however, there are specific rules and exemptions for such things. There are some factors the Australian Taxation Office considers, such as whether the property was inherited before September 20, 1985, and whether it was the main residence of the deceased owner. It varies by location, so it is best to speak with an expert on this subject.