How to Avoid Capital Gains Tax

How to considerably reduce — and in some cases avoid — CGT on an investment property.

Discovering how to reduce capital gains tax when selling an investment property can save you thousands. Many first-time investors are overwhelmed at the thought of paying CGT on hard-earned growth.

The outcome depends on decisions made long before the sale: who owns the asset, how long it has been held, whether it was ever your main residence, and what has been added to the cost base.

How to avoid Capital Gains Tax

Discovering how to avoid capital gains tax when selling your investment property can save you thousands of dollars. Yet so many first-time property investors continue to be overwhelmed at the thought of potentially paying capital gains tax on the hard-earned growth of their investment.

We have put together a ‘how-to’ guide that will show you how you can considerably reduce the amount of capital gains tax you pay and how you can avoid paying it at all.

What is Capital Gains Tax

According to the Australian Tax Office (ATO), when you sell your property, the difference between how much you paid for it and how much you sold it for is known as capital gains. If you lost money on the sale, the difference is a capital loss. Any profit on the sale of your investment property is considered a capital gain, and you will need to declare it on your annual income tax return.

Unless expressly excluded, you are required to pay CGT on the sale of your investment property if you acquired it after 20 September 1985. The gain is added to your income tax return for the relevant year and is likely to push you into a new tax bracket.

The Principal Place of Residence exemption

As a general rule, you can avoid capital gains tax when selling a property if it is your primary place of residence (PPOR), because you usually don’t generate an income from living in your own home. You’ll need to live in the property for a minimum of 6 months from settlement for it to be considered your PPOR.

The ATO considers a property to be your PPOR if:

• you and your family have lived in the property for the full duration that you’ve owned it
• you keep your possessions in the home
• you use the address to receive your postal mail
• the utilities are connected and in your name

Selling your investment property with an SMSF

There are several tax benefits if you purchase your investment property through an SMSF. The fund is only required to pay a 15% tax rate on rental income from the property — substantially lower than other income tax rates in Australia.

If you keep the property for more than twelve months, the tax rate on sale drops from 15% to 10%, a 33% discount on your CGT. And when the SMSF is in its pension phase, you will not be required to pay any CGT on the sale of your investment property.

If you can’t avoid CGT, you may be able to reduce it

Capital gain = selling price – cost base. Your cost base = purchase price + expenses – (grants + depreciation). By adding expenses to your cost base, you reduce the capital gain you declare.

Expenses you can add to your cost base include:

• Incidental costs — advertising costs, legal fees and stamp duty
• Ownership costs — such as council rates incurred but not previously claimed as a deduction
• Title costs — legal fees incurred organising and defending the title
• Improvement costs — such as replacing flooring or installing a deck

Partial exemptions and the 6-year rule

• The 12-month ownership discount — Claim a 50% discount on your capital gain if you have owned the property for at least 12 months before selling it.
• Years lived in vs. years rented — If you rented the property before moving in, the exemption is calculated proportionally. E.g. Cathy rented for 2 years, then lived in it for 8 — on a $235,500 gain she is only taxed on 2⁄10, or $47,100.
• The CGT 6-year rule — Rent out your PPOR for up to six years and, if you sell within that period, you remain exempt from CGT as if you had lived there.

Practical PDF guides prepared by our advisers — free to download and keep.