Capital gains tax and rentvesting




Understanding Capital gains tax for your bottom line


Capital gains tax (CGT) and rentvesting go hand in hand. In Australia is a tax applied to the profit made from the sale of an asset, including property. When it comes to property transactions, understanding how CGT works is crucial for investors and homeowners alike. Recently many people have been asking about how CGT works when you rent a house out before moving in or you live elsewhere but intend to return. This is called rentvesting and it is popular because many cannot buy where they would like to live. As an investment strategy rentvesting can be an excellent way to build equity but knowing about CGT is essential because CGT will impact potential profits.


  1. Calculating Capital Gains


Capital gains are calculated by subtracting the property’s selling price from its original purchase price. However, certain costs associated with the purchase and sale can be deducted to arrive at the taxable capital gain. These costs include:


  • legal fees;
  • stamp duty;
  • real estate agent commissions and
  • any capital improvements made to the property during ownership can be added to the initial purchase price to reduce the taxable gain.


The individual title holder’s tax contribution is considered when calculating CGT. This means that the gain is divided and calculated at the individual rates. The higher income earner will pay proportionally more CGT than the lower income earner on the title.


  1. Primary residence exemption


A primary residence is exempt from CGT. If the property has been your main residence for the entire period of ownership, the gain will be entirely tax-free. However, if the property was used for income-generating purposes, such as renting out entirely or in part, a partial CGT will apply.


  1. Rentvesting and CGT


When you purchase a property, the default is that you would live in that property and it was not intended as an income-earning investment. CGT applies to the portion of time when the property was leased. To avoid CGT, you must live in the house from the first day for a period of up to 12 months before leasing the property. If you lease the property after that the six-year exemption rule applies.


  1. Exemptions for absences


If the property was your main residence but you moved out and rented it, a partial CGT exemption is applicable. The Australian Tax Office (ATO) allows homeowners to maintain the CGT exemption for up to six years if the property is rented out while the owner is living elsewhere. After the six-year absence, the CGT begins again. To avoid the tax the owner must live in the property again for 12 months before another six-year exemption is given.


  1. CGT Discount after 12 months


Investment properties held for a period longer than 12 months reduce capital gain by 50%. CGT is 100% if the investment is sold within 12 months from exchange of contracts. This means that only 50% of the capital gain is added to the individual’s taxable income.


  1. Reporting and payment


When a property is sold, CGT must be reported in the income tax return for the financial year in which the contract to sell was signed. The tax is then payable as part of the individual’s overall income tax liability for that financial year. It’s important to keep accurate records of all costs associated with the property purchase and sale to facilitate the CGT calculation and reporting process – these costs are deducted from the gains.


  1. Seeking professional advice


Navigating the complexities of CGT on property transactions can be challenging. Therefore, seeking professional advice from tax experts or financial planners is highly recommended. They can provide tailored guidance based on individual circumstances, helping to optimize tax outcomes and ensure compliance with ATO regulations.


In conclusion, understanding the intricacies of CGT and on property in Australia is essential for property owners and investors. Rentvesting is one way to build equity and clearly, you do not want that gain eroded. Whether it’s taking advantage of exemptions, discounts, or concessions, staying informed about the tax implications of property transactions can lead to more informed financial decisions. As tax laws may change, it’s advisable to consult with professionals to ensure accurate and up-to-date advice.