What are Capital Gains?
If you own a capital asset (such as real estate or an investment) which grows to be worth more than you initially purchased it for, the increase in value is referred to as a capital gain.
For example, a property purchased for $500,000 that was sold for $750,000 would have a capital gain of $250,000.
In Australia, a capital gains tax (CGT) is levied by the ATO when a person sells a capital asset. Any gain made on the sale of a property or investment is counted as income in the financial year that the asset was sold.
Capital Gains Example
However, the calculation for CGT is more complicated than the formula given above. This is because (in some circumstances) CGT also takes into account the cost of owning, maintaining, and improving the asset. This means that costs such as stamp duty, legal fees, loan repayments, renovations, and title fees are included.
So using the same example as above, if the cost of owning that $500,000 home was an additional $50,000, then for taxation purposes, the cost is considered to be $550,000.
And if you have owned an asset for at least one year, then any gain is immediately discounted by 50% for individual taxpayers.
The equation is altered significantly by these changes. $250,000 taxable income is reduced to $100,000 taxable income ((750,000-550,000)÷2).
The actual income you earn isn’t changed, just the amount of it that is liable to taxation.
The exact amount of capital gain that is liable to taxation varies from person to person and is adjusted according to a number of variables (too many for this article).
In fact, there are some circumstances where a property is fully exempt from CGT. One example is if the property in question is your primary place of residence.
Filing Tax Return with Capital Gains
When using property as an investment vehicle it is essential that you are properly claiming all of your eligible deductions to maximise your capital gains. Although it is commonly referred to by a separate name, capital gains tax is considered part of your income tax. Whenever you make capital gains, it is considered part of your assessable income. However, capitals gain are not automatically withheld. So it is important that you set aside a portion of your capital gains to cover the tax you owe.
Another factor to consider is that the capital gains are considered to have occurred at the time that the contract is entered into, not when it settles. So if you sell a property in June that will settle in August, you are considered to have profited in June.