You generate a taxable capital gain when you sell an asset, like property, for more than you paid. Conversely, you incur a capital tax loss if you sell the asset for less than your original investment.
These gains or losses need to be reported on your income tax return, and you’ll usually owe taxes on the gains. And as capital gains tax is a national tax, you will pay the tax regardless of whether the taxing point arose in Perth or elsewhere in Australia.
What Exactly is Capital Gains Tax (CGT)?
As tax accountants in Perth we are often surprised to hear people talk about CGT as a different tax.
A Component of Income Tax
Capital Gains Tax (CGT) isn’t a standalone tax despite its distinct name. It’s an integral component of your income tax. When you sell an asset for more than you paid for it, the difference is called a capital gain. This gain becomes part of your annual assessable income, influencing your overall tax liability. So, it’s a bit of a misnomer to refer to it as a ‘separate’ tax; it’s more accurate to think of it as a specific kind of income that’s taxable.
Exemptions: Your Primary Residence
Your main home, your “principal place of residence,” is generally exempt from CGT. If you sell your main home at a profit, you usually won’t have to pay additional tax on the gains.
Your main residence does not need to be your current house. There are exemptions for families that move around and relocate. And using these exemptions together with structuring your home loan tax can make a significant difference to a family’s wealth plan.
Importantly a family can only have one main residence. So, a holiday home typically has tax consequences.
The Objective of this Guide
The goal of this guide is threefold. First, we want to clarify Capital Gains Tax and disentangle some of its complexities. The term can be confusing, especially since it sounds like a separate tax when it’s not.
Second, we aim to offer strategies for legally reducing your CGT liability. There are various methods to lower your tax obligations, such as utilising exemptions and discounts that may apply to you. We’ll guide you through these options to help you keep more of your hard-earned money.
Finally, we’ll walk you through calculating your CGT obligations. Understanding the formula and variables that go into determining your capital gains will prepare you for tax time. We’ll offer step-by-step guidelines to ensure you’re not blindsided when lodging your tax return.
Capital Gains Tax might sound daunting, but understanding its ins and outs with the help of a Perth tax accountant can empower you to make better financial decisions. Knowledge about CGT is indispensable whether you’re an investor, a homeowner, a business operator or someone planning for the future.
How Capital Gains Tax Operates
Few people are enthusiastic about paying Capital Gains Tax (CGT), which has been a part of Australian tax law since 1985. It applies to most assets purchased after that year, although certain exemptions exist.
Purpose and Impact
Fundamentally, CGT serves as a government mechanism to tax the growth of your assets. The more profitable your investments, the larger the tax bite if you sell them.
Before introducing capital gains tax, many people tried to change their income to capital gains. So, the introduction of CGT also took away a lot of that structuring people did and simplified the work of the ATO.
Implications for Heirs
It’s also important to know that your capital gains tax obligation can extend to your beneficiaries once you pass away. They may incur CGT if they sell assets they’ve inherited from you. The Australian Tax Office (ATO) is notably patient in this regard, willing to wait for years, if needed, to collect its due. So retaining records for many years is critical with capital gains tax as those same records form part of the cost base of the assets.
Special Cases: Inheritance and More
Interestingly, there are circumstances where you could be taxed without directly selling an asset. For instance, passing assets to your heirs upon your death could trigger tax implications.
In summary, understanding the nuances of CGT from your Perth tax accountant can help you better plan your investments and estate, ultimately enabling you to make more informed financial decisions.
The Intricacies of Calculating Capital Gains Tax
To determine whether you’ve made a capital gain or a capital loss on an asset, you must compare the asset’s sale price with its original purchase price. The difference between these two figures is either your gain or loss. Unlike a separate tax, this amount is folded into your total income for that tax year, affecting your overall income tax liability.
Holding Period and Tax Discounts
Here’s where it gets a bit more nuanced. If you’ve owned the asset for over a year, you could be eligible for what’s known as a CGT discount. This discount is 50% for individual taxpayers, meaning you’d only have to include half of your gain in your taxable income. If the asset is held in a superannuation fund, a 33.3% discount applies instead.
Different Rules for Companies and SMSFs
It’s essential to note that these discounts don’t apply universally. Companies, for example, are not eligible for any CGT discount and are subject to a flat 30% tax rate on their capital gains. On the other hand, Self-Managed Super Funds (SMSFs) face a 15% tax rate but still benefit from the 33.3% discount.
Why the Details Matter
The complexities in the CGT calculation—such as holding periods and varying tax rates—can significantly impact the tax you ultimately owe. Knowing these specifics from your Perth tax accountant can help you strategically manage your assets to minimise your tax burden. Whether deciding the optimal time to sell an asset or choosing the best way to hold it (individually, through a company, or in a superannuation fund), understanding these intricacies can be invaluable for effective financial planning.
What Constitutes a Capital Gains Tax Event?
A Capital Gains Tax (CGT) event is a transaction or an occurrence that triggers a requirement for you to consider the capital gains or losses associated with an asset. These events are not restricted to simply selling an asset; they can also include giving it away, exchanging it, or even being compensated for its loss or destruction.
Timing Matters: Contract vs. Settlement
The timing of a CGT event can vary depending on the asset and the circumstances. In cases where a sale contract is involved—such as when selling real estate—the CGT event is considered to have occurred on the date the contract is signed, not the settlement date. This is an important distinction as it determines the tax year in which the capital gain or loss needs to be reported.
Financial Assets Like Shares
The CGT event occurs when the sale is finalised for financial assets like stocks or shares. This is typically the trade date, not the settlement date when the funds change hands. Again, the specific timing has implications for which tax year the gain or loss will fall into.
If you have an employee share scheme, capital gains tax might apply when you sell or acquire the shares from the employer.
Other Types of CGT Events
Besides selling, other actions can also trigger a CGT event. These can include, but are not limited to:
- Inheriting an asset
- Receiving compensation for an asset (e.g., insurance payout for a damaged property)
- Transferring an asset to a trust or company
- Selling the underlying entity that owns the shares
Why Understanding CGT Events is Crucial
Knowing what constitutes a CGT event and when it occurs is vital for several reasons. Firstly, it allows you to prepare financially for any resulting tax implications. Secondly, it helps you strategically plan the timing of asset disposal to minimise tax liability. Lastly, understanding the timing ensures you report the capital gain or loss in the correct tax year, aiding in accurate and timely tax filing.
By being well-informed about what triggers a CGT event, you can make more strategic decisions regarding your assets and investments.
Strategies for Balancing Capital Gains and Losses
One of the strategic moves you can make to manage your Capital Gains Tax (CGT) liability is to offset your capital gains with any capital losses. This is known as ‘netting’ your gains and losses. If you’ve sold assets at a loss, those losses can be used to reduce the capital gains you’ve realized from other asset sales.
Carrying Forward Losses
There’s no need to fret if you’ve incurred more losses than gains in a particular tax year. The Australian Tax Office (ATO) allows you to carry these net capital losses forward indefinitely into future years. This can be beneficial when you realise capital gains in subsequent years, as you can then use your accumulated losses to reduce your tax liability.
The important part when you incur a capital tax loss is to ensure that your Perth tax accountant has properly prepared your income tax return. This will let the ATO know that you have incurred the loss and provide clear evidence in the future when you seek to recover it.
Limitations on Offsetting
While this strategy can effectively minimise your CGT, it’s important to note that these capital losses cannot be used to offset your regular or ordinary income. They can only be applied against capital gains in the current year or future years if carried forward.
Exemptions to Consider
According to the ATO, certain personal assets are generally exempt from CGT. These exemptions typically include your primary residence, business assets owned by a small business owner, assets in the superannuation fund’s pension phase, and personal-use assets like furniture or personal belongings. Similarly, plant and equipment are often not subject to CGT. These exemptions can play a significant role in your overall tax planning.
The exemptions from capital gains tax are broad and far-reaching so getting advice from your Perth tax accountant can significantly reduce your capital gains tax liability.
Global Reach of CGT for Australian Residents
If you are an Australian resident, it’s crucial to understand that the scope of CGT extends beyond domestic assets. The ATO mandates that CGT applies to any of your assets anywhere in the world. If you own property or financial assets in another country and decide to sell, you must still report the capital gains or losses to the ATO.
Given that other countries will also seek to tax those assets, you will need to consider the tax profile of the other country together with the Australian tax laws. Getting a single point of advice from a tax advisor with a global network, like GGI Global Alliance, is critical as it is easy to get wrong.
Getting advice
The area of capital gains tax is potentially complex and costly. Getting forward-looking advice from a Perth tax accountant like Westcourt with a global network is an intelligent business decision to ensure your family and business wealth tax plan is managed correctly. Given our proven tax leadership, investment in technology and global tax network, why not call Westcourt and see how we can help?
