Capital gains tax (CGT) isn’t actually a separate tax, it’s ‘simply’ the methodology for calculating the taxable amount of any capital gain or loss made on disposal of a capital asset (property, shares, crypto-currency, business assets).
Where a gain is made, the taxable gain amount is included in the taxable income of the individual or entity in their income tax return and taxed at their individual marginal or company tax rate for that year.
Where capital loss is made the loss is available only for offsetting against other capital gains or to carry forward for future offset. No matter how large a capital loss you might make it cannot reduce your other taxable income, which can be a tough pill to swallow if you sell your business at a loss in a year where you otherwise have high taxable income, there is simply no opportunity to use the capital loss on sale to reduce your other taxable income.
The CGT regime in Australia can be complex and varies depending on the type of asset and eligibility to the Small Business Entity (SBE) CGT concessions. The ‘gross’ capital gain is essentially the difference between what you paid for the asset and what you receive for selling it, taking into account purchase and selling costs. The taxable capital gain, however, is often significantly less because of the various discounts and concessions available.
Some CGT basics to consider
Full ‘Main Residence Exemption’
Your main residence/primary place of residence/home (PPR) is exempt entirely from CGT provided the following apply:
- It is your home for the whole period of ownership.
- It has not been used to produce income (think, claiming a portion of costs in your tax return for running a business from home).
- Is on land of 2 hectares/5 acres or less.
- You were an Australian resident for the entire period of ownership.
Foreign residents are not entitled to the main residence exemption for properties sold after June 30, 2020, unless certain criteria are met.
You cannot have multiple main residences at one time for tax purposes, excepting a six month overlap when moving from one to another.
You can continue to treat your former home as your main residence for CGT purposes even though you no longer live in it provided you do not nominate another property as your main residence. If you use it to produce income in your absence the period of renting is less than six years at a time.
Partial ‘Main Residence Exemption’
If you use your former home to produce income for more than six years at a time, you nominate another property as your main residence or you become a foreign resident you may be entitled to a partial main residence exemption on any capital gain made on the property.
Where a property was originally your home, but you are not entitled to a full main residence exemption, there are two options for calculating the taxable gain on disposal:
- Pro rating the actual gain (sale price less costs) for the period the main residence exemption does not apply.
- Substitution of a market valuation (prepared by a registered valuer) at the time the property ceased to be eligible for the main residence exemption as the cost base for CGT.
Example
House ‘A’ bought as your home in January 2000 for $200k, you moved to a new home in January 2010 when the market value of House ‘A’ was $500k. You sold House ‘A’ in January 2020 for $600k.
Main residence exemption calculation:
Option 1: Gross gain $600k less cost $200k = $400k. Main residence is pro-rated, 10 years as main residence divided by 20 years of ownership = 50 percent of the gain is exempt from CGT and the other 50 percent is the gross gain ($200k) which may be eligible for further discounts.
Option 2: Main residence exemption applies to the gain between purchase and where it ceased to be your main residence. Gross gain is sale price $600k less substituted cost base of $500k = $100k which may be eligible for further discounts.
Note: The market value substitution rule only applies where a property was originally your home. You cannot substitute a market valuation as cost base where you establish a property as your home where originally purchased as an investment property, in that case any main residence exemption is calculated on a pro-rata basis.
CGT General Discount
When you dispose of an asset, you can reduce the capital gain by the ‘General Discount’ of 50 percent or one third if the asset is owned by a Self-Managed Super Fund, where the asset was owned for at least 12 months, and you are an Australian resident for tax purposes.
There may be access to a pro-rated general discount amount for foreign residents for assets acquired on or before May 8, 2021, provided they had a period of Australian residence prior to that date.
There is an additional CGT discount of up to 10 percent for Australian individuals who provide affordable rental housing to people earning low to moderate income, increasing the discount to up to 60 percent for those residential properties.
Small Business Entity (SBE) CGT Concessions
The small business concessions and eligibility therefore can be complicated depending on your circumstances, but generally you may be eligible to utilise the SBE CGT concessions provided one of the following applies:
- You are a small business entity with turnover (income) of less than $2 million for the year.
- You, or your asset, are used in connection to a carrying on a small business.
- You satisfy the maximum net asset value test. This test essentially means the market value of you and your related entities’ CGT assets less any liabilities related thereto does not exceed $6 million.
Some assets are specifically excluded from the definition of assets for the purposes of accessing the concessions, generally where a property is used to derive rent it is not eligible for these additional concessions.
The 4 SBE CGT concessions you may be eligible to apply to further reduce any taxable income on sale of a business asset (an ‘active asset’) after any general discount is applied include the following:
15-year exemption
Not one we see often, but a good-one. No CGT applies where you dispose of an active asset owned for 15 years or more and are at least 55 years old and are retiring.
You may also be able to contribute some or all the gain amount to your superannuation fund without affecting your other contribution limits.
50 percent Active Asset Reduction
An additional 50 percent reduction is applied where the asset is ‘active’ which essentially means the asset is a business or used in a business. This concession is optional in application, an example of a time you might opt NOT to reduce your taxable capital gain would be where you are planning to contribute as much as possible to your superannuation fund under the ‘retirement election’ which is in addition to your other superannuation contribution caps.
Retirement Exemption
Capital gains on disposal of active assets are exempt from CGT up to a lifetime limit of $500k if the gain is contributed to a complying superannuation fund OR you are over 55 years old at the date of disposal.
No tax is paid on contribution to your superannuation fund and the contribution does not use up any of your concessional/non-concessional contribution caps.
If you do use this election and contribute the gain to your superannuation fund you must ensure the appropriate forms are submitted within seven days of making the election - liaise with your financial advisor, fund(s) and accountant to ensure an administrative error doesn’t end up costing you in forgone tax savings.
Active asset rollover
The rollover allows you to defer all or part of a capital gain for up to two years from disposal of the asset.
If you purchase a replacement small business asset, or improve an existing one, one year before or within the two years of disposal of the asset, the gain will carry forward as a reduction of the cost base of the replacement asset essentially delaying any tax on the gain until disposal of the replacement asset.
This process can be repeated over and over, provided all eligibility criteria met, meaning tax will only be assessed and payable on disposal of the final business asset. And if other concessions apply at that time, such as the retirement exemption, potentially no tax will be payable at all.
You can apply as many of the small business CGT concessions as you are eligible for until the capital gain is reduced to zero.
In closing
While not light reading, I’ll admit, having a broad understanding of the CGT regime is valuable, particularly for small business owners and those now dabbling in share and crypto investments. If you are considering buying or selling assets, please ensure you liaise with your accountant before signing any contracts to ensure you are clear on all potential tax consequences thereof.
Disclaimer: This article contains general information only. Regrettably, no responsibility can be accepted for errors, omissions or possible misleading statements or for any action taken as a result of any material in this guide. It is not designed to be a substitute for professional advice, as such a brief guide cannot hope to cover all circumstances and conditions applying to the law as it relates to these items.
