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How to Avoid Capital Gains Tax on Investment Property: Common Strategies for Investors
Capital Gains Tax (CGT) is a significant factor for property investors to consider when selling an investment property. But what exactly is CGT, and how can you reduce or avoid it? The good news is that CGT is often less complicated than it seems, and there are multiple strategies to minimise your tax liability.
CGT refers to the tax you pay on the profit (capital gain) made when selling an asset, such as property or shares. A capital loss, on the other hand, occurs when you sell an asset at a loss.
CGT applies based on the profit made, which is included in your taxable income for the year. The amount you owe in CGT depends on your overall income and how long you held the property. If you have owned the property for over 12 months, Australian residents for tax purposes are eligible for a 50% CGT discount.
For instance, if you purchased a property for $450,000 (including fees and stamp duty) and later sold it for $700,000, your capital gain would be $250,000. With the 50% discount, you would only declare $125,000 of that gain on your tax return.
Your family home or Principal Place of Residence (PPOR) is generally exempt from CGT, provided it meets the "main residence exemption" criteria. The property must be lived in by you and your family for the duration of ownership, must not be rented or used to generate income, and should have utilities connected.
Vacant land, however, does not qualify for a PPOR exemption, and properties on land exceeding two hectares do not fully qualify for the exemption.
This rule allows you to treat an investment property as your PPOR for up to six years, even while renting it out, provided you return to the property within six years. If you sell the property within this time, it is exempt from CGT, making it an ideal option for homeowners who temporarily rent out their home.
For example, if Jane rents out her property for five years, moves back in for a year, and then rents it out again, the six-year period resets, allowing her to potentially avoid paying CGT when selling.
This rule provides a six-month window to own two PPORs without CGT. It applies when you purchase a new home before selling your current one. To qualify, the home you are selling must have been your main residence for at least three continuous months in the year before the sale, and it must not have been used to generate income during that time.
If your investment property has been rented out through a community housing provider (CHP) for at least three years, you may qualify for an additional 10% CGT discount. This brings your total discount to 60%, as it stacks on top of the general 50% discount.
You can reduce your CGT liability by increasing your property's cost base. This includes all the costs associated with purchasing, holding, and selling the property, such as loan repayments, stamp duty, property management fees, council rates, and renovation costs. Properly calculating the cost base can significantly reduce your taxable capital gain.
The ATO requires an accurate valuation of your property when determining CGT. A precise property valuation, especially if done retrospectively, helps in establishing a fair cost base, which can further reduce your CGT liability.
Investors have various ways to manage or reduce CGT on investment properties. Whether through exemptions like the six-year and six-month rules or by leveraging discounts for affordable housing, there are strategies to potentially save thousands. Always consult a financial expert to tailor strategies to your unique situation and maximise your tax benefits.
Disclaimer: This article provides general information and does not constitute financial advice. Always seek independent advice specific to your circumstances before making any financial decisions.
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