OPINION: IF you are looking to buy an investment property, you will need to consider the implications of Capital Gains Tax (CGT) in case you ever want to sell. Gains made from the sale of investment properties are generally subject to CGT.
A capital gain or capital loss is the difference between what it cost you to buy the property and what you received when you sold it. If you make a capital loss, you cannot claim it against income but you can use it to reduce a capital gain in the same income year.
If your capital losses exceed your capital gains or you make a capital loss in an income year and you don’t have a capital gain, you can carry the loss forward indefinitely and deduct it against capital gains in future years.
If you use your property to earn income at any time, you will have entitlements and tax obligations. It is wise to keep proof of your income-related expenses from the beginning to ensure you can claim everything you’re entitled to.
Remember to keep your building costs separate to the decline in value of any depreciating assets. By doing so, you can claim your deductions correctly and work out your capital gain accurately when you sell the property.
Main residence exemption and the six year absence rule
Property you have purchased since tax on capital gains came into effect on 20 September 1985 is subject to CGT unless it was and continues to be your main residence for the life of the asset. Partial CGT exemptions apply if the property was your main residence for part of the ownership period.
Also, some people own a main residence but live in another property. Examples include those who have moved interstate or overseas for work purposes and rent that property to live in, but want to keep their own property and rent it out to earn an income.
Alternatively adult children may decide to move back in with their parents if they are trying to save money or find it hard to make home loan repayments. People in these situations may be able to take advantage of the ‘six year absence rule’.
Property owners who vacate their main residence and use it for income producing purposes while absent (i.e. renting it out), can continue to have it treated as their main residence. However, to be eligible for the full main residence exemption the maximum period of time that it can be used to produce income during a period of absence is six years. You are then entitled to another maximum six-year period each time the dwelling again becomes and ceases to be your main residence.
This can be an ideal way of having your cake and eating it, as you are earning an income from a property rental and then may have a nil CGT bill when you ultimately sell it.
Timing can be important
When you sell or otherwise dispose of a property, the time of the CGT event is when you enter into the contract, not when you settle. If there is no contract, the CGT event is when the change of ownership occurs.
A common misconception occurs here because the timing of when you enter into a contract to purchase a property can be crucial. Many people mistakenly think that a settlement in a new financial year will be assessed for tax purposes at this time, when in fact it was assessable in the previous financial year when the contract was entered into.
In many cases a person’s assessable income is higher, this of course may not be the desired outcome.
If you bought a CGT asset such as property (after 20 September 1985) and sold it less than 12 months after you purchased it you will not qualify for a the 50% CGT discount. Property held for longer than 12 months will qualify.
In a rapidly rising market this can be a valuable concession as only half of your capital gain will be added to your assessable income in that financial year. This could make a significant difference to your overall tax bill.
CGT rules can become complex so it may be wise to get some professional advice before proceeding.
By Peter Wolfram, technical services manager, MyWealth, Commonwealth Bank.* Wolfram’s website is https://www.mywealth.commbank.com.au/property/tax-tips-when-selling-investment-property-infocus201303
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