Selling an investment property in Australia often raises concerns about Capital Gains Tax (CGT) and how it will impact your overall profit. While there’s a lot of discussion on how to reduce capital gains liability and utilise the concessions and exemptions provided by the Australian Tax Office (ATO), relatively little conversation exists about situations where a property is sold at a loss.
So, can you utilise negative net capital gains to your advantage?
The answer is yes, and modern property investors need to understand how a capital loss affects their tax liabilities and overall financial strategies not only now but also across future years.
Understanding the Capital Gains Tax Framework
Capital Gains Tax (CGT) is imposed on profits made from selling or exchanging a capital asset in Australia.
Unlike a separate tax, CGT is treated as part of your income tax assessment, calculated at the individual’s marginal tax rate. It applies when a CGT event occurs, or the sale of an asset producing assessable income, such as selling an investment property or shares. Essentially, a gain from a CGT event will increase your taxable income.
The amount of CGT owed depends on the difference between the asset’s cost base (initial cost plus additional expenses and incidental costs related to ownership, improvements, and disposal) and the proceeds from the sale or exchange. The resulting amount is categorised as either a capital gain or a capital loss, depending on whether the proceeds exceed or are less than the cost base.
The Australian Taxation Office (ATO) administers CGT and provides guidance on its calculation and payment, offering a host of exemptions and considerations that can help you increase your tax benefits against investment income.
What is a Capital Loss Tax in Australia?
A capital loss specifically refers to the treatment of losses incurred from the sale or disposal of capital assets. Suppose the proceeds from selling a capital asset are less than the base cost of that asset. In that case, the difference is considered a capital loss, carrying potential tax implications to offset any other gains.
The Australian Taxation Office (ATO) has strict rules and guidelines regarding utilising capital losses against capital gains. The most important is that individuals cannot directly deduct capital losses from their income. Instead, they can apply their net capital losses against their capital gains.
Can You Carry Forward Capital Losses into Future Income Years?
So, what happens when the capital losses exceed the capital gains for a year, or an individual has no capital gains?
Well, it is also possible that the consequent net loss can be carried forward to capital gains in future years. There is no time limit on how long capital losses can be carried forward in Australia.
Again, whether you are applying capital losses in the same income year as you were selling assets or are applying them to a future year, the process always involves reducing your taxable capital gains, thereby minimising your capital gains tax (CGT) obligation.
Working with a registered tax agent, quantity surveyor or financial advisor and effectively managing capital losses can help property owners navigate Australia’s tax benefit solutions.
CGT Discount and Exemptions
In most cases where you make a net capital gain, the ATO will allow you to benefit from certain discounts or exemptions depending on certain factors, such as how long you’ve held the property.
For example, if you hold an asset for longer than 12 months, you can benefit from a 50% CGT discount, meaning you’ll only pay tax on half of the net capital gain on the asset.
Keep in mind that if the asset is your home and you first started using it for rental or business less than 12 months before selling it, you can’t use the CGT discount.
Individuals and Australian Trusts can discount a capital gain by 50%.
Complying Superannuation funds also receive a 33.3% discount if they dispose of an asset held for over 12 months.
You may be interested in reading how SMSF property investing works.
There are also some exemptions from CGT. For example, your main residence (family home) is typically exempt from CGT as long as specific eligibility criteria are met.
How to Turn a Net Capital Loss into an Opportunity Come Tax Time
When discussing CGT assets in Australia, most investors are aware of the necessity to pay capital gains tax when they realise a profit upon selling.
As discussed above, a capital loss transpires when the sale price of an investment property falls below the original purchase price. While this situation may seem unfavourable, it might be unavoidable, and there are strategies to mitigate the impact of such a loss.
Firstly, no CGT is payable if a capital loss is incurred, as losses are not subject to taxation. In fact, capital losses can be utilised to offset capital gains from the sale of other assets. We can do this by deducting the capital loss amount from any other capital gains achieved within the same financial year, thus reducing overall capital gains tax liability.
Should there be no capital gains available to offset the capital loss, or if the capital loss surpasses the capital gains realised in the same year, the unused losses can be carried forward. These losses carried forward can be applied in subsequent years to offset future capital gains when they materialise.
It is crucial to note, however, that capital losses cannot be offset against other income from alternative sources as a direct tax deduction, nor can they be transformed into revenue losses in subsequent years.
Case Study: Calculating Capital Loss on Investment Property
Meet Sean, an investor in his late 40s residing in Australia.
Over the past decade, he has built a diverse property portfolio. Recently, he decided to sell two of his properties to assist in covering his daughter’s tuition fees and living expenses as she gained admission to a prestigious university overseas.
The first property, an inner-city apartment, was originally acquired for $500,000. Over time, demand for such apartments surged due to their proximity to workspaces and the vibrant city life. Sean managed to sell it for $850,000, thus achieving a capital gain of $350,000.
The second property, a suburban family home, was bought for $620,000. Unfortunately, changes in work patterns and a preference for more affordable areas led to decreased regional demand. Forced to sell, Sean received $595,000, resulting in a net capital loss of $25,000.
In this scenario, Sean could strategically leverage Australian tax regulations to diminish his tax liability.
By offsetting the capital loss from the family home against the capital gain from the apartment, he decreased his taxable capital gain for the financial year from $350,000 to $325,000.
If Sean lacked other capital gains in the current financial year, he could carry forward the unused capital loss of $25,000 to offset future capital gains.
Case Study: Claiming Capital Loss on Properties Purchased After 2017
Consider Jessica, a savvy property investor based in Sydney.
In 2020, she purchased a property built in 2015, which had functioned as a rental property since its inception. Being aware of diverse investment strategies and tax complexities, Jessica engaged the expertise of Duo Tax to prepare a Tax Depreciation Schedule immediately after the purchase.
Due to the changes to Australian tax laws in 2017, depreciation on second-hand assets were no longer eligible for investors to claim depreciation on. Since Jessica’s property was built before her purchase date, all assets within were deemed ‘second-hand.’
However, this limitation did not restrict leveraging the depreciating value of these assets.
Recognising this situation, Duo Tax provided Jessica with a Capital Loss Report attached to the Tax Depreciation Schedule. This report outlined the diminishing value of the second-hand assets for each financial year.
Fast forward to 2023, Jessica upgraded the property’s air conditioning system from a split system to a modern ducted one. Keep in mind the Capital Loss Report by Duo Tax still outlined the residual value of the split system air conditioning unit at $800. By removing the split system unit, she could claim this residual value as a capital loss.
Simultaneously, diversifying her investments, Jessica opted to sell certain shares, yielding a profit of $2000 subject to Capital Gains Tax (CGT).
Ordinarily, Jessica would have been liable for tax on these capital gains. But, because of the loss from removing the air conditioning unit, she could offset her capital gains tax liability from the shares. Thus, the $800 capital loss from the air conditioning unit reduced her taxable capital gain from $2000 to $1200.
Jessica’s benefits from her smart decisions did not stop there. She also improved the property by replacing the existing air conditioning unit with a modern ducted system. This improvement allowed her to claim depreciation on the new unit’s cost, including installation expenses, further reducing her tax liability.
This shows how Jessica changed what initially appeared to be a drawback – the inability to claim depreciation on second-hand assets – into an opportunity.
Why Should You Make a Capital Gain/Loss Strategy
Creating a capital loss tax strategy can be complex, so it’s crucial to seek help from tax professionals. Keeping accurate and complete records of all transactions tied to capital assets will also simplify this process. Such comprehensive record-keeping should include the date of purchase and sale, the purchase and sale prices, and all costs associated with acquiring and disposing of the asset.
Armed with a grasp of the fundamentals related to capital losses carried forward, property owners can better approach the management of their capital assets.
Seeking Professional Advice to Handle CGT Events
As investors contemplating the tax implications of selling an investment property in Australia, we must seek professional advice from a qualified accountant or tax advisor. These experts can assist us in comprehending potential capital losses, possibilities for exemptions, and any other tax concessions we might be eligible for.
Should our investment property incur a capital loss, similar to the situations faced by Sean and Jessica, we may have the opportunity to apply this loss to offset any capital gains derived from other investments in the ongoing financial year or carry it forward for offsetting future gains.
If you are selling your investment property, you will need to obtain a Capital Gains Tax Property Valuation Report from an experienced Property Valuer.
A tax advisor can ensure that our reporting accurately reflects our capital losses and exemptions. It is also crucial to remain vigilant regarding any changes in legislation and regulations that could impact our investments. Collaborating closely with a proficient tax specialist can ensure that we remain well-informed and updated on applicable changes and their potential repercussions on the sale of our investment property.
Key Takeaways
- Understanding the implications of capital losses on investment properties is crucial for effectively managing financial strategies and tax liabilities.
- Sean’s scenario demonstrates that investors can transform an unfavourable situation into an opportunity by using capital losses strategically to offset capital gains and reduce overall tax obligations.
- Partnering with qualified tax professionals allows investors to navigate the complexities of tax laws and maximise the benefits of their investment property transactions.
- To ensure proactive management of investment properties and the best use of every opportunity, even in the face of capital loss, it’s essential to stay well-informed and seek professional advice.
Duo Tax is here to help you navigate your investment property tax obligations, including depreciation schedules and capital losses. Contact our expert team today for guidance and support tailored to your unique situation.
Let Duo Tax empower you to make the most of your property investments.
