Unlike buying your own home, investing in property is a business venture and there's a lot you need to know well before you dive in and buy. All those house flipping TV shows featuring harassed couples battling to renovate investment properties in record time in pursuit of big profits can be fun to watch. However, how many of them mention potential hiccups such as capital gains tax?
What is capital gains tax?
Before you take your first big step into property investment there's a lot to learn about the tax implications, including capital gains tax (CGT) which comes into play when it comes time to sell your property. Capital gains tax does not apply when you sell your own home (your principal place of residence) but can create a significant dent in your profits when selling an investment property.
In short, capital gains tax is levied on the profits you make when you sell an investment property purchased on or after September 20, 1985. Any gain you make on the sale of an investment property is included in your assessable income in the financial year in which you sell the property and this gain is calculated by subtracting the costs involved in acquiring and holding the property from the proceeds of sale of the property.
What CGT exemptions apply?
Both full and partial exemptions from capital gains tax apply in certain circumstances. For example, if you have held the property for more than 12 months you are entitled to a 50 per cent discount off your CGT liability. In some cases, you may be able to avoid CGT entirely. You may be eligible for a full exemption if:
You purchased the property before September 20, 1985.
You sell a property that is considered your principal place of residence. In this case, you need to be living in the property while you renovate it to on-sell rather than renting it out. You will miss out on rental income, but all profits on the sale will be CGT-free as long as the land area is less than two hectares. If you buy an investment property, rent it out, then later move into yourself then you are partially exempt from CGT should you decide to sell the property at a later date.
Under the 'Temporary Absence Rule', if you move out of your home and rent it out the property will still be treated as your principal place of residence for a period of six years, so if you sell within this time you are exempt from CGT if you make a profit from the sale.
You purchase a residential investment property through your Self-Managed Super Fund (SMSF). If you wait to sell the property until after you retire, then you'll pay no CGT on the sale.
Under the recently announced 2017 Federal Budget, from January 1, 2018, there will be a new CGT discount for people who invest in affordable housing managed by registered community housing providers and hold the property for a minimum of three years.
What happens if I make a loss?
If you make a capital loss on the sale of an investment property you will not be liable for CGT plus you will need to speak with your accountant as this need not be a complete disaster. The loss can be carried forward in future years and be offset against capital gains you make.
As you can see, capital gains tax is a complex issue with many variables. Always seek expert and up-to-date advice from your accountant and local Century 21 real estate agent before buying or selling an investment property.