Finance & Tax
Capital gains tax (CGT) is one of the biggest tax considerations for property investors. When you sell an investment property for more than you paid for it, the profit is subject to CGT. Understanding how CGT works, how to calculate your cost base, and the strategies available to minimise your liability can save you tens of thousands of dollars.
Capital gains tax is not a separate tax. It is part of your income tax. When you sell an investment property, the capital gain (or loss) is added to (or deducted from) your taxable income for that financial year, and you pay tax at your marginal tax rate.
A capital gain occurs when the sale price (capital proceeds) exceeds the cost base of the property. A capital loss occurs when the cost base exceeds the sale price. Capital losses from property can be offset against capital gains from other assets (such as shares) in the same or future financial years, but they cannot be offset against ordinary income such as salary.
CGT applies to investment properties acquired on or after 20 September 1985. Properties acquired before that date are CGT-exempt (pre-CGT assets). The CGT event occurs on the date you sign the contract of sale, not the settlement date.
If you hold an investment property for at least 12 months before selling, you are eligible for a 50% CGT discount. This means only half of the capital gain is added to your taxable income. This discount is available to Australian resident individuals and trusts, but not to companies.
For example, if you purchase a property for $500,000 and sell it 5 years later for $700,000, your gross capital gain is $200,000. With the 50% discount, only $100,000 is added to your taxable income. If your marginal tax rate is 37% (plus 2% Medicare levy), the tax on the gain is approximately $39,000 instead of $78,000.
The 12-month holding period is calculated from the contract date of purchase to the contract date of sale. If you sell even one day before the 12-month mark, you lose the entire 50% discount, so timing your sale carefully is important.
The cost base is not simply the purchase price. It includes all of the costs associated with acquiring, holding, and disposing of the property. A comprehensive cost base includes the purchase price, stamp duty paid on the purchase, legal and conveyancing fees (both purchase and sale), building and pest inspection fees at purchase, loan establishment fees (but not ongoing interest), capital improvements made during ownership (renovations, extensions, structural improvements), non-deductible holding costs (such as interest if the property was not rented for a period), and agent's commission and marketing costs on sale.
Importantly, expenses you have already claimed as tax deductions (repairs, maintenance, insurance, management fees) cannot be included in the cost base. You cannot deduct an expense twice. However, capital improvements that were not deductible as current expenses are included.
If you claimed depreciation deductions under Division 40 (plant and equipment) or Division 43 (capital works), the amounts claimed reduce your cost base. This means that while depreciation saves you tax during the holding period, it increases your CGT liability when you sell. Your quantity surveyor's depreciation schedule is essential for calculating the adjustment accurately.
Your main residence (the home you live in) is generally exempt from CGT under the main residence exemption. However, if you move out of your home and rent it out, the interaction between the main residence exemption and CGT becomes more complex.
Under the 6-year absence rule (section 118-145 of the Income Tax Assessment Act 1997), if you move out of your main residence and rent it out, you can continue to treat it as your main residence for CGT purposes for up to 6 years. This means if you sell within 6 years of moving out, the entire capital gain is exempt from CGT. If you move back in, the 6-year clock resets.
The catch is that you can only have one main residence at a time for CGT purposes. If you buy a new home and claim it as your main residence, you cannot also claim the 6-year exemption on the old property for the overlapping period. You may need to apportion the gain between the exempt period and the non-exempt period.
If the property was your main residence for part of the ownership period and an investment for the remainder, you calculate the CGT using the "income-producing use" proportion. For example, if you lived in the property for 5 years and rented it for 3 years (beyond the 6-year rule), 3/8 of the gain would be subject to CGT.
There are several legitimate strategies to reduce your CGT liability when selling an investment property.
The ATO requires you to keep CGT records for 5 years after the CGT event (the sale). However, since you need records from the date of purchase to calculate the cost base, you effectively need to keep records for the entire period of ownership plus 5 years after selling.
Essential records include the contract of purchase and settlement statement, stamp duty receipt, all invoices for capital improvements, depreciation schedules from your quantity surveyor, records of any period the property was your main residence, loan documents showing establishment fees, the contract of sale and agent's commission invoice, and conveyancing and legal fee invoices for both purchase and sale.
Digital storage is acceptable and recommended. Create a dedicated folder for each property and store scanned copies of all relevant documents. Abode maintains a complete financial record of your rental income and expenses during the period you use the platform, which can assist with CGT calculations when you eventually sell.