Capital Gains Tax on Investment Property

If you're like 99% of Australians, the word "tax" is enough to get the adrenaline pumping and set off fight-or-flight mode, but when properly planned for and budgeted, taxes aren't such a bad thing (at least not as surprising!). One tax you need to properly plan and budget for when selling real estate investments is capital gains tax on an investment property.

You may be wondering:

• Why does capital gains tax matter for property investing? 

• How much tax will I pay when I sell my investment property? 

• How do I calculate capital gains tax in Australia? 

• Are there any capital gains tax exemptions? 

In this article, we'll share all you need to know about capital gains tax on investment properties. We'll discuss what it is, how to calculate it, and some tips and tricks to reduce the amount you have to pay (Our favourite part!). While Investie can't help you get rid of Capital Gains Tax, we can help you be more aware of what it is so you know to consult a tax professional before selling your investment properties.

What is Capital Gains Tax (CGT) on an Investment Property?

According to the Australian Taxation Office, "Capital Gains Tax (CGT) is the tax you pay on profits from disposing of assets including investments, such as property, shares and crypto assets. Although it is referred to as 'capital gains tax', it's part of your income tax. It's not a separate tax."

Basically when you sell an asset for more than you paid for it, you have a "capital gain" and you have to pay a portion of that "gain" in tax. On the other hand if you sell an asset for less than you paid for it, you have a "capital loss" which you can use to offset capital gains in the current year or future years. We will talk about how to calculate CGT in more detail later in this article.

CGT applies a little differently for investment properties and the home you live in. In this article we'll discuss CGT implications on investing since that's where our expertise and focus lies. If you want to learn more about the impact of CGT on selling your home, as well as any exemptions and special conditions, you can find this information on the Australian Taxation Office website, here.

According to the Australian Taxation Office, for rental/investment properties, "a capital gain or loss is the difference between what it cost you to obtain and improve the property (the cost base) and the amount you receive when you dispose of it." If you make money, you have to pay CGT. If you lose money, you can use the amount of the loss to offset capital gains.

How is CGT Calculated? (Step-by-Step)

By now you may be wondering, how is CGT calculated? Calculating taxes can be a big headache for someone who isn't a tax accountant, but the nice thing about CGT is that it is calculated through a simple 8-step process. 

Step 1: Figure out how much you received for the property

When you dispose of an asset/property (think you sell it or it gets destroyed and you receive an insurance payout), the amount you receive is your "capital proceeds."

(Expert tip: If you want to be cheeky and sell to friends or family for less than it is worth to get out of paying CGT, think again! Your tax implications will be assessed based on the market value of the property.)

Step 2: Figure out your costs for the asset

This is the cost to buy the asset plus any other costs that you had to acquire, hold, and dispose of the asset. This is known as your "cost base." 

If you make a loss on the asset, your situation is a little different and you can find out more at the end of this section. By the way, this has never happened to an Investie client!

Step 3: Deduct your cost base from your capital proceeds

If you take the values from Step 1 - Step 2 and the result is more than zero, you have a capital gain. If it's less than zero, you have a capital loss.

Step 4: Repeat steps 1-3 for each CGT event in this financial year

(This only applies if you dispose of more than one asset!)

Step 5: Subtract any capital losses from your capital gains

In this step you reduce your capital gains by subtracting any losses. If you have losses left over from previous years you want to subtract those first. If you have no allowable capital losses, you can skip to step 7.

Step 6: Figure out if you have any actual capital gains

If your number from step 5 is greater than zero, you will move on to step 7. If it is less than zero, you have a net capital loss and you can skip to step 8.

Step 7: Apply CGT discount

If you are an Australian resident who has owned the asset for at least 12 months, you are eligible for a 50% CGT discount. If you owned the asset for less than 12 months, you cannot discount it. (There may be other special discounts here that you are eligible for, please consult a tax professional for more information!)

Step 8: Report on your income tax return

If you have a net capital gain, you will pay tax on the gain at your marginal income tax rate. If you have a loss you cannot deduct it from other income, but it will carry forward to reduce capital gains in future years.

For more detailed information, you can check out the Australian Taxation Office's page here to see them break these steps down into more detail.

Example: working out CGT for a single asset

Nick buys an investment property for $600,000 and sells it 2 years later for $700,000.

He has no other capital gains or losses.

Using the steps above, Nick works out his capital gain as follows:

1. The capital proceeds from the CGT event are $700,000.

2. The cost base is $630,000, made up of:  

• purchase costs of $500,000 + $15,000 stamp duty + $1,200 conveyancing fees (btw, this also includes your buyer's agent fee!)

• sale costs of $1,300 conveyancing fees + $15,000 agent's commission.

4. Nick's capital gain on the investment property is:
   $700,000 - $632,500 = $67,500

5. Nick has no other capital gains or losses, so he skips to step 7.

6. This step is not applicable.

7. This step is not applicable.

8. Nick can use the CGT discount to reduce his capital gain because he is an Australian resident and owned the asset for at least 12 months:
   $67,500 × 50% = $33,750

9. Nick reports a net capital gain of $33,750 and a capital gain of $67,500. He will pay tax on the net capital gain at his marginal income tax rate.

How to Minimize Capital Gains Tax When Selling

As mentioned in our calculation section above there are some simple ways to reduce your tax liability. 

1. In the unfortunate case of a capital loss, always report it. These losses can be deducted from future capital gains. 

2. Keep track of the costs of buying, selling, and holding the property. Deducting these costs can save you thousands of dollars every time you sell a property. 

3. Holding onto a property for more than 12 months will mean you get a 50% discount on your CGT (as an Australian resident, if eligible).

Capital Gains Tax on Investment Property FAQs

When do I have to pay capital gains tax?

Anytime you dispose of an asset you need to pay capital gains tax. This could be selling an asset, having the asset destroyed, or giving the asset away.

What is my tax liability if I sell to a friend at a discount?

In this case you will be taxed on the fair market value of the asset.

How much is capital gains tax?

This depends on a number of factors. How long did you hold the asset? How is the asset classified? Are you holding the asset as an individual or as a company? You can find more detailed information here. For specific tax-related questions, please contact a tax professional.

Can you help me figure out my taxes?

While we are knowledgeable on tax implications of your investment property, we aren't qualified tax professionals. If you'd like to be put in touch, reach out for a recommendation or two.

Does it matter what kind of property I sell?

For the most part no, but in some special circumstances such as when you sell affordable housing, or other special classifications of housing, there are different discounts. You can find more information here.