Capital gains tax explained, Part 1: Common misconceptions
Questions on capital gains tax on investment property were among the top five queries to financial advisers during this month’s Financial Planning Week, the Financial Planning Association says.
Australians’ love of residential property and the favourable tax treatment of investments in real estate mean capital gains tax is on many people’s radars, explained Stephan Strategic Certified Financial Planner, Joe Stephan.
“People are happy to reduce tax now through strategies such as negative gearing but eventually there will be a capital gain and there will be tax to pay,” said Stephan, who lectured on taxation at La Trobe University.
Capital gains tax (CGT) can be confusing, particularly if the property was purchased before September 21, 1999 when the rules were simplified.
There are variations in the way the tax is applied depending on the situation. For example, CGT paid on investments held inside superannuation is different from CGT paid on assets held by an individual.
“It’s also tied with timing,” Stephan says. “How long you hold an asset determines how much you pay.”
A common misconception about CGT is that it is charged at a flat rate. That’s not the case, said Stephan.
“The amount paid depends on your marginal tax rate and that depends on the income you generate,” he added.
This means it can be tax effective to time the disposal of an asset so that the sale goes through in a year when the person’s taxable income will be lower.
“Sometimes people like to wait until they are getting towards retirements and start taking an income stream from their private pension so they don’t have to pay any income tax. Then their capital gain is assessable at a lower tax rate,” Stephan said.
CGT was introduced in 1985, so the sale proceeds of properties that were bought before then are not subject to the tax.
The CGT discount was introduced on 21 September, 1999. This is a 50% discount that applies to the capital gain made on assets bought since that date if they have been held for more than one year, Stephan explained.
Most people understand there is no CGT to pay on the sale of the family home, said Stephan, but many people are confused by the special rules that apply to other properties, such as an inherited home.
“You don’t have to pay CGT on inherited property unless you sell it. The cost base might change and not be the purchase price but you don’t pay CGT until the property is sold,” Stephan said.
Different rules apply when people turn their home into a rental property or move into a property that was formerly an investment. Stephan warns that some mortgages do not allow the property to be converted into an investment. For simplicity, some people like to sell up and buy another similar property rather than converting the property’s use.
This is the first in a series of three articles explaining CGT. To see Part 2: Deceased estates, click here. To see Part 3: Investment property appreciation, click here.