What is capital gains tax and how does it apply to real estate?

Your real estate holdings are major financial assets, so it’s essential to understand what taxes you’ll need to pay and when you’ll need to pay them. The capital gains tax on real estate (CGT) is a crucial property tax. In this article, we’ll explain the tax to you, look over CGT exemptions and reductions and show you how to work out what CGT you might need to pay.

What is capital gains tax?

CGT is deducted from the capital gain you earn. Capital gain refers to the profit you make when selling assets for a higher price than the cost of their original purchase. CGT is not just applied to investment property, as capital gains taxes are also levied on shares, foreign currencies, leases and different personal use assets. However, here we’re only concerned with capital gains tax on real estate.

Investment properties are capital assets with a separate tax regime to main residences. If you sell an investment property for more money than you originally paid for it, you’ll have earned a net capital gain, from which capital gains tax is deducted.

When it comes to real estate, as soon as you sign the contract to sell your property, you are subject to capital gains tax, applicable from the financial year in which your property was sold. Ensure you’re prepared by holding on to all relevant documentation so you can quickly calculate capital gains tax on real estate when the time comes. Contracts, interest paid, receipts, expense records and valuations are all valuable things to have on hand.

How much is capital gains tax on real estate?

Rates of CGT vary. If a business owns the investment property, capital gains tax is fairly simple. Companies are not eligible for CGT exemptions and discounts, so they pay a flat tax rate on their capital gains at their relevant corporate tax rate.

The situation is slightly different for self-managed super funds, and depends on if you are in a pension phase – so, if you’re over 65 years old, retired and taking a pension from your fund, then there may be 0% tax on your capital gain. Generally, though, you can expect to have a 33.3% discount to capital gains and pay 15% tax on the remaining assessable income. As mentioned, if the property owner is an individual who owned the asset for under 12 months, the total capital gain is added to their taxable income & tax is paid at the relevant marginal tax rate.

Individuals with longer-term property ownership have two main options. Firstly, there’s the CGT discount pathway: if you’re an Australian resident, you can receive a 50% discount on your capital gain. Secondly, there’s the indexation method for properties purchased before 1999. This option multiplies the initial price by the inflation rate since the asset purchase, up to the consumer price index that applied in the third quarter of 1999. This inflation increases your initial purchase price, reducing your taxable capital gains.

Property investors should use the method that reduces capital gains taxes the most. Your best choice can be tricky to calculate, so we recommend using an online CGT calculator. If you make a loss on the sale of your property, you can subtract that capital loss from a capital gain in other tax years, reducing your tax bill. However, you can’t apply capital loss flatly to assessable income and use it to reduce taxes paid on ordinary earnings.

Exemptions and reductions to CGT

Capital gains tax on real estate has a series of exemptions and reductions you can use to secure higher profit from your assets. The first and simplest exemption from capital gains tax is for properties purchased before 20 September 1985. If you acquired your property before this date, the sale is generally exempt from capital gains taxes, meaning you likely won’t have to pay tax on any profits.

Another exemption from CGT is the place of residence exception. The Australian Taxation Office will provide an exemption from CGT for your main residence. A property counts as your main residence if it has served as your family home, if you keep your personal belongings there, if it is your primary address, and if services are connected to the home in your name. If your property meets some or all of these criteria for the entirety of your ownership period, you should receive a primary residence exemption and avoid paying any CGT.

Confused about capital gains tax on real estate? We can help

Semple is the real estate agent Perth trusts. Our family-run business has three decades of experience providing exceptional service to all our clients. We know how daunting handling real estate can be, and we’re always ready to help you discuss your options and ensure you’re getting the most out of your property. Get in touch today and speak with our team for top-quality real estate advice. We look forward to hearing from you!