What is Capital Gains Tax?
Capital Gains Tax, or CGT for short, is the tax you pay on any profit made from the sale of a capital asset, such as property, land, building or shares.
Both capital gains and capital losses form part of your taxable income and are reported on your Tax Return where you will have to pay tax on any gains. Although it is referred to as Capital Gains Tax, it is still part of your income tax and is not separate.
If you happen to have made capital gains for the year, it will ultimately increase the amount of tax you need to pay that financial year.
How does Capital Gains Tax work
If you sell a capital asset for more than what you originally paid for, this is a capital gain and you will have to pay tax on the gained amount. Likewise, if you sell the asset for less than what you paid for, it’s a capital loss.
Common situations for capital gain;
- When you sell an asset, i.e. building, land or shares
- Selling part of a business or your whole business and in some cases when you alter your business structure
- If you stop being an Australian resident
Essentially, CGT works by taxing any increase in value from the time an asset is acquired and sold. The capital gain is taxed within that financial year the asset was sold.
How do you calculate capital gains or loss tax?
A capital gain or loss occurs when you sell a capital asset. It’s the difference between the capital asset purchase cost and its sale price. Let’s take a look at capital gains on property and shares:
When calculating capital gains on the sale of a property:
Jane purchased a home for $450,000 and sold it 1.5 years later for $550,000.
$550,000 – $450,000 = $100,000 gain/profit.
This means Jane will declare $100,000 capital gain in her Tax Return. Note, a Capital Gains Tax Discount is available to Jane in this example.
Remember, the capital gain from the sale of a property happens on the date you enter a sale contract and not the settlement date. So, if you enter a sale contract on 22nd April 2021 and the settlement doesn’t happen until 20th August 2021, you will still need to include the capital gain for your 2020-21 Tax Return.
How to calculate Capital Gains Tax on shares?
Jane buys some shares for $5,000. She owns the shares for 6 months and sells them for $5,500. She has not recorded any other capital gains or losses.
This means Jane will need to declare $500 capital gains in her Tax Return and pay tax on her individual income tax rate.
What about a capital gains discount?
When you sell an asset, you may be eligible for a CGT discount, providing you:
- Have owned the asset for at least 12 months
- Are an Australian resident for tax purposes.
With this method, after calculating your capital gain, you then apply a 50% discount.
If you have any capital losses from other assets, you’ll need to subtract these from your capital gains before applying the discount. (refer to capital loss tax section below)
If you’re eligible for the discount for a capital gain, you reduce the remaining capital gain on that asset by 50% and report this amount in your Tax Return.
So, let’s go back to Jane, for example:
Jane made a capital gain of $100,000 on the sale of her property. Because she held her asset for more than 12 months, she is able to use the CGT discount to reduce her capital gain.
$100,000 x 50% = $50,000.
This means Jane will report a net capital gain of $50,000 on her income Tax Return and will pay tax on this gain.
Assets that are owned for less than 12 months will not be eligible for CGT discount.
What are capital gains tax exemptions
Capital Gains Tax didn’t kick in until 20 September 1985, which meant that every asset purchased after this date was subjected to Capital Gains Tax. However, there are some exemptions:
- Your main residence, except in the below circumstances;
- CGT may apply if you rent part of it out
- You use it for business
- Is on more than 2 hectares of land
- A car or motorcycle
- Depreciating assets (used only for tax purposes)
If you sell any of these items during the year, Capital Gains Tax usually does not apply.
However, CGT does apply to the following if sold or disposed:
- Real estate (residences other than your main residence, holiday homes or investment properties)
- Shares, units and similar investments
- Personal use assets above a certain value
- Major capital improvements made to land
How can I claim capital loss?
So, what if you made a loss on the sale of your asset? A capital loss is when you sell your asset for less than the price you purchased it for. It does not reduce other taxable income like your wages, but it can reduce capital gain.
However, if you have gains and losses in the same financial year, this will be taken into your CGT calculation:
Jane sold her shares for a $1,000 loss
$100,000 (gains) – $1,000 (loss) = $99,000
$99,000 x 50% = $49,500
If you only have a capital loss for the financial year, the loss can be carried over to the following year where you have a capital gain and can offset the gain.
Do you need to pay Capital Gains Tax in Australia?
The best way to calculate your capital gains or losses will ultimately depend on your own individual circumstances. Capital Gains Tax is a complex matter, so it’s always best to speak to us first (your tax agent) to ensure you get the best possible outcome for your situation.
Get in touch today at [email protected] or call one of our Numbers Geeks on 1300 707 117