11 Strategies To Minimise Your Capital Gains Tax
Capital gains tax (CGT) is the tax charged on the gain you make from selling an asset e.g. real estate, which you acquired after 20 September 1985.
For those in the highest tax bracket, you could be taxed up to 45% on your property’s capital gain when you sell.
The good news is that with a bit of knowledge and forward planning you can substantially minimise your capital gains tax, or even avoid it altogether.
1. Hold for 12 months
Once you’ve owned a property for 12 months you’re automatically entitled to a 50% tax discount on any capital gain you make when selling the property.
As an example, say you bought an investment property a few years back and then recently sold it, making a capital gain of $100,000.
Straight away you can reduce your taxable amount by 50%, so $50,000.
If your salary was $90,000, then your taxable income becomes $90,000 + $50,000 = $140,000.
The next step is to work out which tax bracket you are in by consulting this table on the ATO website.
Your total income of $140,000 puts you in the fourth row, and you can then work out the total CGT you will pay as $50,000 (capital gain) x 37% (tax rate) = $18,500.
2. Move in right away
By moving in straight away, you help qualify the property as your Primary Place Of Residence (PPOR).
Your main residence is exempt from CGT, so when you sell the profit is all yours.
As an added bonus, you also satisfy the requirements for receiving the first home owners grant (but only if it’s a new home, or if you’re in WA for a short time longer).
If however you originally rented the property out, and then moved in at a later date, you are still entitled to a partial exemption.
The partial exemption is calculated as a proportion of the ‘years lived in’ to ‘years rented’.
Brad buys a property and rents it out right away.
2 years later he decides he wants to move in, and lives there for 6 years before selling it, making a capital gain of $200,000.
He only has to pay CGT on one quarter of that amount, which is the 2 years the property was rented, out of the total 8 years he held the property for.
Brad’s taxable amount is therefor only $50,000. Even better, because he’s held the property for more than 12 months he can further reduce this by 50%, leaving him with a total increase to taxable income of just $25,000.
3. Revalue before you rent it out
If you rent your property, the capital gain is calculated by the difference between the final sale price and the property value at the time it was rented.
However, if you didn’t get the property revalued at this time then the value will be taken from the original purchase price.
To avoid paying more tax than necessary, make sure you always get the property revalued by a licensed valuer before renting it out. You then have a new cost base from which to calculate any future capital gains.
- Gary buys a house in 1998 on the Central Coast for $200,000 and moves in
- In 2008 just before renting the property out, he has the property revalued at $500,000.
- In 2010 Gary sells the house for $480,000.
His capital gain is calculated by $480,000 (sale price) – $500,000 (value prior to renting).
For tax purposes Gary has actually made a capital loss of $20,000 and can offset this amount from a current or future capital gain.
If Gary was in the third tax bracket this would be a saving of $20,000 x 32.5% = $6,500, plus the overall capital gain of $280,000.
4. Monitor your rental periods
You are allowed to rent out your property for up to 6 years and still be entitled to a full CGT exemption, provided you are not using another property as your main residence. This is commonly known as the ‘6 year rule’.
The 6 years doesn’t have to be continuous either; if the property goes vacant for a time then this period is not added to the 6 years.
This means that after renting your property out for say 3 years, if you were unable to find tenants for a few months or if you undertook some renovations, the counter stops. You can then rent out the property again for a further 3 years and still sell the property without having to pay tax on any capital gains.
If you do exceed the 6 years, then you need only pay tax on the proportion of time that the property was rented for longer than 6 years.
- Sarah buys an apartment in Melbourne for $400,000 and moves in right away to qualify the apartment as her PPOR.
- After 2 years she moves overseas and rents out her apartment. At the time she has her apartment revalued at $500,000.
- Sarah returns from overseas after 7 years and sells her property for $700,000.
Her capital gain is taken from the revalue prior to renting, so her gain is assessed as $200,000.
Sarah’s taxable gain is then $200,000 x 1/7 (she’s only liable for 1 year out of the 7 it was rented)
But, she’s also entitled to the 50% discount, so this amount further reduces to $14,286. Assuming a tax rate of 37% her total CGT is then $5,286.
Ultimately she’s made a capital gain of $300,000 but has only had to pay $5,286 in tax, or 1.76%.
Like some more examples? Here’s a recent video from the ATO (June 2014) which runs through a couple of likely scenarios when selling a rental property that was also your home.
An additional note for those with multiple properties; the 6 year rental period is cumulative between properties. That is, if you own 2 properties with one as your PPOR and then rent both out, after just 3 years CGT will come into effect on your main residence because the cumulative rental period is 6 years.
5. Choose your main residence wisely
If you own more than one property then the ATO gives you the power to choose which property you wish to treat as your main residence, assuming both are eligible.
If you decide to sell, you can save a lot of money by choosing the property with the higher capital gain as your PPOR.
Ryan buys a property in Sydney and moves in right away.
2 years later he is relocated to Brisbane and rents out his Sydney property. After 2 years renting in Brisbane Ryan finds a property to buy and moves in.
Another 2 years later Ryan decides he wants to sell his Sydney property. Since it has only been rented for 4 years it is still eligible as his main residence.
Ryan gets a free valuation from local real estate agents for both his properties, and finds that his Brisbane property has gone up $20,000. His Sydney property is now worth an estimated $80,000 more.
After completing the sale, Ryan nominates his Sydney property as his main dwelling in his tax return, and enjoys a tax free capital gain of $80,000.
For those that are switching to a new property, there is a three month window between buying a new house and selling your old one before CGT applies.
For further information and more examples on choosing your main residence check out the ATO’s guide to treating a dwelling as your main residence after you move out.
6. Consider moving in again
It was mentioned earlier that you can rent out your property for up to 6 years and still enjoy full exemption from CGT.
But did you know what you can earn another 6 years exempt period by living in your residence again?
To qualify for another 6 years you just need to treat it as your main residence again (Source and example).
What does this involve? The ATO has put together a general list, which includes:
- Moving yourself and your belongings in
- Making it your address for the electoral roll, bills, bank statements etc.
- Connecting utilities in your name (and actually using them)
The downside is that you must kick out any existing tenants, miss out on rental income which is helping to pay off your mortgage, and then find new tenants again. But, if you decide to eventually sell, then the tax savings are potentially huge.
Also, don’t forget that you can’t treat a second property as your main residence in this time. You can’t move back and forth between multiple properties to avoid paying tax on all of them.
7. Renovations, repairs and depreciation
Renovating is not only a great way to manufacture capital growth by adding value to your property, but you can also use the costs to reduce your capital gain.
When you use the ATO’s capital gain or capital loss worksheet there are three main categories which can be added to the cost base of your property:
- Incidental costs such as stamp duty and legal fees.
- Ownership costs such as council rates, land tax, strata fees and interest. If you rent your property out and claim these as deductions then they may no longer be added.
- Capital expenditure e.g. renovations
Capital gain / loss = Sale price – Cost base (purchase price plus the above 3 items)
It’s important to differentiate between renovations and repairs though, because if you’re renting out your property then repairs are typically claimed as deductions, and deductions actually reduce your cost base i.e. they increase your capital gain.
The exception is initial repairs when you buy the property, which are not allowed to be claimed as deductions, and so can be added to the properties cost base similar to renovations.
So while renovation costs add to your cost base and reduce your capital gain, if you were to claim depreciation for your upgrades then although you would receive tax benefits each year (2.5% over 40 years), you would end up paying this back through capital gains tax if you eventually sold.
Bit confusing? This video from the ATO runs through a good example of everything just mentioned, and also shows how CGT is broken up if you bought with a partner.
Depreciation is a complex topic which you can learn more about here. For even further reading you might find these resources from the ATO useful:
8. Self-Managed Super Fund’s
A Self-Managed Superannuation Fund (SMSF) or “do it yourself super”, is a form of superannuation fund where you as a trustee and member have responsibility over the management, investment and administration of the fund.
The general idea then is that you use your super fund to purchase the property along with a SMSF property home loan, which is then paid off with your super contributions.
There are however some rules:
- The property cannot be lived in by you, or anyone else in your fund, or anyone related to you or anyone in the fund
- Funds can only be used to maintain a property, not improve it i.e. don’t buy a place that needs renovating
SMSF’s typically enjoy much more relaxed capital gains tax rates, and in some situations are even completely exempt.
Be aware that setting up a SMSF is not a simple task, and you should never attempt to do so without first seeking professional advice.
I’m also definitely not advocating using your SMSF as a means of tax evasion. The ATO have announced that they are commencing a large scale crackdown on those abusing the system, so be careful.
For some though it is a viable option, and one that many Australian’s use successfully.
9. Offset your gain
If you’re still expecting to have to declare a significant capital gain, then you should try to offset your gain by reducing your taxable income in other ways.
Here are some options:
- Buy another property and prepay the interest for the first year (fixed rate loans only)
- Prepay your life or income insurance for a year (actually prepay anything that’s tax deductible)
- Take some unpaid leave from work
- Make some super contributions. Concessional contributions are taxed at only 15%. Note that for 2015/2016 concessional contributions are capped at $30,000/$35,000 for those under 50/over 50. More info here.
- Donate to charity
- If your income varies from year to year, wait for a low income year and then sell
There’s plenty of other ways but that’s a good start and should get you thinking.
10. Don’t sell
It might sound silly, but it’s actually one of the most popular strategies with professional property investors.
What do they do then? It’s a method known as refinancing.
First of all, you need to get your home revalued to work out how much theoretical capital gain you’ve made.
You can then approach your lender and refinance your loan based off the new property value, i.e. you can borrow additional money because your LVR is now much lower so you have the option to borrow more.
(Not sure what LVR is? Check out the free property beginners guide to learn more)
In this way you are able to access the equity you have in your property and then use that money for a new investment e.g. buying a second property. And of course, you’ve avoided paying any CGT.
- Alex and Rachel buy an apartment for $500,000 with a loan of $400,000 (LVR = 80%)
- After 5 years, they’ve paid off $50,000 in principal on their loan, and the apartment has been revalued at $650,000
- They want a bigger home and need money for a deposit on a house. How much equity can they access?
Their current debt is $350,000 ($400,000 loan less $50,000 principal repaid).
Their equity = $650,000 (current property value) – $350,000 (current debt) = $300,000
For a good property in a good area, bank’s will usually grant as much as an 80% LVR loan on equity, so Alex and Rachel would be able to access up to:
$300,000 x 80% = $240,000
This money can be used as a deposit for a house, and they can rent out their current apartment to cover the repayments on their existing loan.
This is actually the beginnings of how real estate tycoons buy more and more properties and end up with seriously large property portfolios, but that’s a topic for another day.
11. Sell in July
With the financial year ending on 30 June, by selling in July you give yourself a full 12 months to implement one or more of the options above, such as reducing your taxable income.
At the very least, you keep the money for another year and at least gain some interest.
If you had a taxable gain of say $100,000 then by holding onto the money from July to October (16 months) and putting it in a 5% interest savings account you could potentially earn over $6,500 in compound interest, or reduce interest repayments on a home loan.
As a general rule, if you’re ever expecting to receive a tax refund then you should aim to file your tax return as early as possible.
If you’re expecting to owe money it doesn’t matter when you file; your payment is usually due 2-3 weeks after close of lodgement period i.e. mid November.
Some strategies are pretty simple, while others are a bit more creative and require some work and careful planning. Your personal situation will determine which combination of strategies is best for you.
There is one more strategy however which I have saved until last, and it’s the most important of all. If you do not implement this one correctly then all other strategies above are likely to fail.
By law you need to keep records of everything that affects your capital gains and losses for up to 5 years after the CGT event (after you sell the property).
Here are the main ones:
- Purchase contract
- Stamp duty
- Legal fees and any other fees arising from purchasing the property
- Property valuations
- Renovation costs
- Ownership costs: interest, strata fees, land tax, council rates, water charges, insurance, repairs
- Past tax returns indicating which items have and have not been claimed as a deduction
- Proving rental/non-rental periods: lease agreements, mail, electoral roll details, gas/electricity/phone bills
- Sales contract
- Selling fees e.g. agent’s commission
One last thing – if you’ve found this information helpful could you please do me a HUGE favour and share it around because the more people who are aware of this stuff the better. Cheers!