When considering any investment, it is important to carefully consider both the short term and long term tax liabilities. We see that for many people, the concept of capital gains tax (CGT) is somewhat misunderstood. In this article, we look at what constitutes CGT and some simple strategies to help you minimise this tax.
What is a ‘capital gain’?
You make a capital gain (or capital loss) when a CGT ‘event’ occurs. These events can happen when you:
• sell or change ownership of an asset or investment, such as property or shares
• have your shares redeemed, cancelled, surrendered or considered valueless by a liquidator
• receive a payment from a company as a shareholder (other than dividends)
• give away, lose or destroy an asset
• are no longer an Australian resident.
CGT events must be declared on your annual income tax return and are taxed on top of your regular income at your top marginal rate. However, assets acquired before 20 September 1985 are exempt from CGT considerations.
What is a ‘capital loss’?
When you sell an asset for less than you initially paid for it, you make a capital loss. When your total capital losses for the year outweigh your total capital gains, you will finish up with a net capital loss for the year.
Minimising your CGT liability
If you have made a capital gain, there are a few strategies that you could consider to reduce the amount you need to pay:
1. Use a capital loss to offset your tax liability
Selling poorly performing assets before 30 June means any capital loss can be offset against a realised capital gain from another asset, thus reducing CGT payable. The realised funds may then be used to re-invest in opportunities that are more suitable. However, selling an asset at the end of the current financial year and immediately repurchasing the same asset after 30 June constitutes a ‘wash sale’ in the eyes of the ATO, and the capital loss may be disallowed.
2. Keep an investment for at least 12 months
Another way to reduce CGT is to hold on to the investment for more than 12 months. Since 21 September 1999, investors have been entitled to claim a 50% discount on capital gains they make on assets held for longer than a year.
3. Delay any gain until the new financial year
If you are thinking of selling a profitable asset, such as shares or property, it may be worth deferring this sale until after the end of the financial year. By doing so, you will delay incurring CGT for another financial year. So, while you will still need to pay the CGT eventually, freeing up short-term cash flow may be beneficial, depending on your circumstances.
4. Discount method versus indexation method
You have the option to use the indexation method to calculate the CGT payable if you have acquired your assets between 20 September 1985 and 21 September 1999.
This technique takes into account inflation and you will pay tax only on the capital gain in excess of inflation. You can usually decide on the option that will ensure the least amount of tax is paid.
5. Use carry-forward tax losses to reduce CGT
Capital losses incurred in previous tax years that have not already been offset against capital gains may be carried forward in future tax years and can mitigate the effect of any future CGT liability. Check your past income tax returns or ask your accountant to determine whether this is an option for you.
If you are in any doubt or would like advice on how to manage your assets and minimise CGT, please contact us for advice specific to your situation.