“It’s not about what properties you own; it’s about how you play the game.” – Monopoly Board Game
Just like in Monopoly, owning the right properties is only half the battle.
The key to winning is strategically managing your assets to minimise risks and maximise returns.
In the world of property investments, smart structuring and understanding capital gains tax (CGT) on property in Australia can be your secret to landing on ‘Free Parking’ instead of ‘Go to Jail’.
So, how well are you playing the game?
Playing the Property Game Right
The property investment landscape is like a high-stakes game of Monopoly.
It’s thrilling, it’s challenging, and if you don’t plan your moves carefully, you could find yourself paying a lot more than you bargained for.
In Australia, one of the biggest pitfalls for property investors is capital gains tax (CGT).
It’s the fee that can turn a seemingly profitable sale into a taxing ordeal – literally.
Understanding how to structure your property investments and minimise CGT can be the difference between winning big and losing your hard-earned profits.
Understanding Capital Gains Tax on Property in Australia
In most cases, when you sell a property for more than you paid for it, you will have made a profit on the investment (referred to as a “capital gain”). The capital gain will fall within the reaches of the CGT legislation and will be included in the taxpayers assessable income to determine the amount of tax payable (if any). Sounds simple right……..? But there’s a catch: the eventual tax payable on the profit can vary greatly depending on how the property ownership was structured and how the capital gain is calculated.
Key Elements:
- CGT for Individuals vs. Companies: Capital gains on investments held by Individuals are taxed at the individuals’ marginal tax rate, but they may be eligible for a 50% discount if they’ve held the investment property for more than 12 months and are Australian residents for tax purposes. Companies, on the other hand, are taxed at the full corporate rate of between 25% – 30% without access to any discounts.
- CGT for a Discretionary Trust Vs Individual – Holding a property in a Discretionary Trust vs in an Individual’s name can be a mixed bag. An Australian tax resident trust also has the benefit of the 50% discount if an investment is held for at least one year (similar to individuals). However, a discretionary trust also has the benefit of choosing how the capital gain is distributed between the beneficiaries, and ultimately who pays tax on the disposal. So if a beneficiary has no other income, this can significantly reduce the tax payable on the capital gain.
That being said, there are also negatives to using a trust structure for property investment. These include that trusts do not enjoy the tax free threshold with reference to state based Land Taxes in many states.That a trust is unable to distribute revenue losses (revenue losses occur when the deductible expenses outweigh the rental income received in any given year), as trusts are required to carry forward revenue losses until the such point as the trust makes a revenue profit (at which point, the losses can be applied to reduce the profit).Capital Gains must be distributed, as such, if all available beneficiaries are already in high tax brackets, then this option may not be as tax effective as other options.
- CGT for a Self Managed Super Fund (SMSF) Vs Individual – Holding a property in a SMSF can be one of the most CGT effective structures. Capital Gains on property are taxed at 0% if the SMSF is in pension mode or are taxed at 10% if the SMSF is in accumulation mode. Revenue profits arising from the investment property are also taxed at either 0% (if the SMSF is in pension mode) or 15% (if the SMSF is in accumulation mode). See our other articles on SMSF.
- Short-Term vs. Long-Term Gains: Properties held for less than a year are taxed as short-term gains, which means no discount. For properties held for a year or more, the 50% discount can significantly reduce your CGT liability (if held in the right structure).
- Exemptions and Concessions: Certain exemptions, like the main residence exemption, can completely eliminate CGT on your family home. There are also specific concessions for small business owners that can effectively reduce the CGT to zero.
Why It Matters: Getting investment ownership wrong can cost you a substantial portion of your profit through tax payable, so understanding the rules is crucial for every property investor.
CGT Exemptions and Discounts
When it comes to reducing your capital gain, applying CGT exemptions and discounts can be a game-changer.
One of the most significant exemptions is the main residence exemption, which can completely eliminate CGT on your family home. In most cases, this means if you sell your primary residence, you won’t have to pay tax on the profit.
Another powerful tool is the 50% CGT discount available to individuals and trusts who have held the property for more than 12 months. Complying superannuation funds enjoy a similar, but reduced 33.33% discount.
This discount for individuals and trusts effectively halves the capital gain, significantly reducing the amount of tax payable. For example, if you made a $100,000 profit on an investment property held for over a year, the discount would reduce your taxable gain to $50,000.
There are also other exemptions and discounts to consider. For instance, small business owners may qualify for specific concessions that can further reduce their tax liability.
By understanding and applying these exemptions and discounts, you can strategically manage your property investments to minimise your tax burden and maximise your returns.
How To Calculate Capital Gains Tax
Calculating Capital Gains Tax (CGT) on an investment property might seem daunting, but breaking it down into steps can simplify the process. Here’s how the Australian Taxation Office (ATO) calculates CGT:
- Determine the Capital Proceeds: This is the amount you receive from selling the property. It includes the sale price and any additional payments you receive as part of the sale.
- Calculate the Cost Base: The cost base is the total amount you’ve spent on the property. It includes the purchase price, plus any costs associated with buying, holding, and selling the property, such as legal fees, stamp duty, and renovation costs.
- Subtract the Cost Base from the Capital Proceeds: If the capital proceeds exceed the cost base, you have a capital gain. If the cost base is higher, you have a capital loss.
- Repeat steps 1-3 for each CGT event you have had in the same financial year.
- Subtract your capital losses from your gains: if there are no capital losses skip to step 7. If you have capital losses from prior years, then subtract these first. You can choose the order in which the capital losses are applied to capital gains (if there were multiple capital gains made in the same year), this may be a critical decision.
- If the remaining amount: is more than zero then continue to step 7, if the remaining amount is less than zero then continue to step 8, as this is your capital loss amount.
- Apply Any CGT Exemptions or Discounts: Where available, reduce the capital gain by applying any relevant exemptions or discounts. For example, if you’re eligible for the 50% CGT discount, halve the capital gain.
- Report the Net Capital Gain or Loss on Your Income Tax Return: The final step is to report the net capital gain or loss on your income tax return. This amount will be added to your taxable income for the year or carried forward to later years where step 6 resulted in capital losses.
For instance, if you sold an investment property for $500,000 and your cost base was $400,000, your capital gain would be $100,000. Applying the 50% CGT discount would reduce this to $50,000, which you would then report on your income tax return (assuming there was only one CGT event for the year).
By following these steps, you can accurately calculate your CGT and ensure you’re paying the correct amount of tax on your property investments.
Common Mistakes in Investment Property Structuring
Investing in property can feel like a straightforward game, but even the savviest investors can land in hot water by making avoidable mistakes.
- Mistake 1: Holding properties in personal names without considering trusts or companies.
- Example: John buys a high-value investment property in his own name. When he sells it, he faces a hefty CGT bill that could have been mitigated with a different ownership structure.
- Solution: Consider using a family trust or company or another member of the family to hold property assets, which can offer greater flexibility and potential tax benefits.
- Mistake 2: Failing to plan for CGT when transferring property between family members or business entities.
- Example: Sarah transfers a property to her son without considering the CGT implications. She ends up with an unexpected tax bill that could have been avoided with proper planning.
- Mistake 3: Ignoring the implications of changing tax laws on property investments.
- Example: The recent changes to CGT discount eligibility for non-residents caught many investors off guard. Staying informed and planning ahead is key to avoiding costly surprises.
Strategies for Minimising Capital Gains Tax Liability on Property in Australia
It’s not enough to own property; you need to own it the right way. Here’s how to optimise your property structure for CGT efficiency, including taking advantage of capital gains tax exemptions:
Using Trusts:
- How It Works: A discretionary trust can distribute rental income and capital gains to beneficiaries in lower tax brackets, reducing the overall capital gains tax liability.
- Example: A property held in a family trust can have its capital gain distributed to beneficiaries who are students or retirees, thus taking advantage of their lower tax rates. Capital losses can also be used to offset gains, reducing the overall tax burden. Unused capital losses can be carried forward to offset future gains.
Company Structures:
- Pros and Cons: While holding property in a company can provide asset protection and flexibility, the downside is that companies don’t get the 50% CGT discount available to individuals.
- Example: An investor using a company structure avoids personal liability but misses out on significant CGT savings.
Superannuation Funds:
- Benefits: Using a self-managed super fund (SMSF) to hold investment properties can offer substantial tax benefits, especially in retirement when the tax rate can be as low as 0%.
- Example: Jane uses her SMSF to purchase a commercial property. When she retires, the rental income and capital gain are tax-free, maximising her retirement income.
Timing is Everything: Selling and Purchasing at the Right Time
Knowing when to buy and sell property is crucial to minimising CGT.
Timing Sales:
- Holding properties for more than 12 months can give you access to the 50% CGT discount.
- If you’re planning to sell, aim for a year when your other income is lower to reduce the CGT payable. Planning for future capital gains can help you strategically time your sales to minimise tax liabilities.
Purchasing Considerations:
- Plan purchases around your personal and business cash flow to avoid disruption. Avoid impulsive buys that don’t align with your overall investment and tax strategy.
- Capital losses can be used to offset future capital gains, reducing taxable gains in subsequent years and decreasing overall capital gains tax liabilities. If you have made a Capital Gain and are holding assets that have an unrealised capital loss, consider realising the loss so that your Capital Gain is reduced. You can buy the asset back at the lower price taking into consideration transaction costs and stamp duty.
- Consider selling properties over multiple years instead of all at once, spreading out your CGT liability and avoiding a spike in your tax rate.
The Role of Professional Advice in Property Structuring
Navigating the maze of CGT laws and property structuring options can be overwhelming. Here’s why professional advice is invaluable:
- Why You Need an Expert: Tax law is complex, and one wrong move can lead to a significant tax bill or legal complications.
- Finding the Right Advisor: Look for a tax advisor who understands both property investments and CGT intricacies.
- The Cost of Getting It Wrong: An unexpected CGT bill can erode your investment returns, and poor structuring can expose you to unnecessary risks.
- All people are Unique: Every Taxpayer has a unique set of goals, needs and situations that affect how they should structure their property purchases.
Winning the Property Investment Game
Smart property structuring isn’t just about avoiding taxes – it’s about maximising returns and securing your financial future. With the right strategies, you can play the property game like a pro, landing on ‘Free Parking’ instead of ‘Go to Jail.’ Stay informed, plan strategically, and remember that every move counts.
Your Property Tax Specialists
Navigating CGT and property structuring can be complex. At Bishop Collins, we specialise in helping investors like you optimise their property portfolio for maximum tax efficiency.
Contact us today to learn how we can help you stay ahead in the property game and remember, you’re not alone in business .