You’ve secured an investment property, or maybe you’ve got a couple under your belt – great! What’s next? It’s time to brush up on your tax knowledge; specifically, captain gains tax.
Capital gains tax (CGT) – what is it?
If you acquired a rental property after 19 September 1985 (or have made certain capital improvements on a property you acquired before this date) – you need to know what CGT is. If you sell (or cease to own) a rental property, you can make either a capital gain or loss.
To understand CGT, we must first define capital gain and capital loss.
For a property sale to make a capital gain, the capital proceeds your receive from the sale must be more than the property’s cost base. A capital loss is the opposite, whereby the property’s reduced cost base exceeds those capital proceeds.
Capital gains tax (CGT) is the tax you pay on profits from disposing of assets, including investment properties. This tax is included within your income – it is not a separate tax. The act of disposing of an investment (typically through selling) is what triggers a CGT event.
How to manage CGT
Tracking all records of your expenses will help you correctly calculate the amount of capital gain and capital loss you have made when a CGT event happens. These records will relate to your ownership and every cost associated with acquiring and disposing of property – ensuring you pay the right amount of CGT.
There are penalties for not keeping a record of everything that affects your capital gains and losses for at least five years after the CGT event. These records should include the following:
- The date you acquired the asset
- The date you disposed of the asset
- The date you received anything in exchange for the asset
- The parties involved
- Any amount that would form part of the cost base of the asset
- Whether you have claimed an income tax deduction for an item of expenditure.
If the sale of your rental property includes depreciating assets, a balancing adjustment event will happen to those assets. You should apportion your capital proceeds between the property and the depreciating assets to determine the separate tax consequences for them.
You can make a capital loss (or, in some circumstances, capital gain) when you dispose of a depreciating asset, to which the new rules about deductions for decline in value second-hand depreciating assets apply. There are different rules for the decline in value if certain second-hand depreciating assets are purchased with your residential rental property. If you use these assets to produce rental income from your residential rental property, you cannot claim a deduction for their decline in value unless you are using the property to carry on a business or are an excluded entity.
Gain or loss – what does it mean for your income?
The amount of CGT you acquire and how it impacts your tax return will depend on whether you end up with capital gain or loss.
Capital gain will increase the tax you need to pay, so it’s important to work out how much tax you will owe and set aside the funds to cover it. On the other hand, capital loss can be offset against any capital gains in the year they occur and reduce the tax you need to pay – that’s why it’s critical to include any losses on your tax return.
If you’re looking for more investment property information – check out the other parts of our ‘Tax Tips for Property Investors’ series or get in contact with us here for a personalised tax assessment or property portfolio review.