How to Avoid Investment Property Tax on Capital Gains – Legally of Course
“In this world nothing can be said to be certain, except death and taxes.” Little has changed since Benjamin Franklin penned those words nearly 225 years ago.
Imagine what you could accomplish toward your investing goals if you could buy and sell real estate in Australia without any concern for paying taxes. Imagine that there was no stamp duty upon settlement, no state land tax, and most essentially, no capital gains tax.
Okay, so that was a nice thought. Now bring your head back down out of the clouds and let’s get down to the real business.
What Is Capital Gains Tax?
The capital gains tax (CGT) is a tax you pay on any profit you make from the sale of assets, like real estate and shares. Your net capital gain for your property is the difference between the selling price and any costs associated with acquiring, holding and disposing of the property.
In Australia, the CGT is not a separate tax. Capital gains are simply added to your overall assessable income and tax is calculated at your marginal tax rate for the year.
While profit from the sale of your personal residence is generally exempt, any other realized gain from real estate will attract the CGT. Feel free to head over to the always exciting and entertaining ato.gov.au website, where you can learn more.
The Capital Gains Tax Discount
In addition to offering some CGT concessions to small businesses, the ATO has instituted a CGT discount of 50 percent for individuals and trusts that hold a particular asset for at least twelve months.
So, a net capital gain of $200,000 would be reduced to $100,000. It is then added to your taxable income for the year.
It sounds generous enough. But even after this discount, the sale of a property can push you into a much higher bracket and reap devastating consequences on your total tax bill.
Nonetheless, the CGT discount was well received by investors and has done a lot to prop up real estate values in Australia. In the four years following the introduction of the discount in 1999, house prices have literally doubled.
But, even better than a discount is the complete avoidance of the CGT – or is it? Here’s seven, including some not so attractive ways to avoid a CGT bill.
Seven Legal Ways to Avoid Investment Property Tax on Capital Gains
1. Sell Your Property For A Loss.
You’re probably thinking, “Wow, that is really bad advice,” but, at least you’ve avoided the CGT. The point is this: If you sell your Aussie investment property for a profit, you will most likely pay the CGT. There’s practically no way to avoid it.
So, rather than stress out about paying tax, as long as there’s an after-tax profit, rejoice that you’re moving in the right direction. I remember Steve McKnight once saying, “If you’re not paying tax, you’re not making money.” Taxes are an inevitable, although often unwelcomed result of being a successful and profitable investor.
2. Sell The Property You’ve Been Holding For The Past 30 Years.
If you’re under 50, there’s probably little chance this applies to you. If you’re over 50 and this does apply to you, well, you may have mistaken your rental properties for your children.
It wasn’t until September 20, 1985, that the CGT laws were enacted in Australia. So, the tax applies only to assets acquired on, or after that date.
If you have a property that you acquired prior to that date, you’re holding a “Get Out of CGT Free” card. Just be sure that you enjoy this free ride, because it will likely be your last one – at least in Australia, that is.
3. Decide To Never Sell Your Property.
Contrary to the previous suggestion, this is how most people avoid the dreaded CGT. They plan to hold their property forever. It’s definitely one way to avoid, or at least defer, the investment property tax, but it may not always be the most profitable decision for the long term. Before you choose this option, ask yourself two key questions:
- Have You Confused Unrealised Gains For Profit?
Because CGT is payable only upon selling your property, which is realizing your gain, as long as you hold your property, assuming it continues to appreciate in value, you have a never-ending tax-sheltered growth of equity.
The problem is that real estate doesn’t go up in value forever. Most of us have never experienced a long-term bear market in property, so we’ve been conditioned to believe this is one investment that can defy the laws of gravity.
Rather than selling, many investors borrow against their growth in equity to finance other deals. This may keep you moving forward for a while, but what if your highly-leveraged property decreases in value? You could end up owing the bank more than it’s worth.
Sooner or later, the bank will stop offering you mortgages, as your limited income brings you to the end of your serviceability. Then you’ll have little choice but to free up your equity by selling. That is, as long as you’re not so cross-collateralized, that it’s impossible to sell.
- Are You Holding A Low-yield Property Just To Avoid Paying Tax?
One of the first “ah-ha!” moments for many of Steve’s Property Apprentices is the realization that the equity locked up in their long-term buy and hold properties has become lazy.
The property that once cost them $200,000 that was earning $300 per week rent, which is a 7.8 percent gross yield, is now worth $450,000 and bringing a $400 per week rent, which is only a 4.6 percent yield.
Their equity was working really hard for them, but now it’s sitting on the couch eating a bag of potato chips. Sometimes, the only way to keep moving forward toward your goals and keep your money working hard is to sell your property and just pay those taxes.
4. Move Overseas To A Tax Haven.
If you’re really determined to stick it to the ATO, you could move to a tax-friendly nation like Belgium, Malaysia, Belize and Hong Kong or, wait for it: New Zealand.
I’ve coached some Kiwi investors, and they have a huge leg up over us Aussies. New Zealand has no capital gains tax, no land tax and they pay no stamp duty. Technically, if you purchase land for the purpose of resale, you may be taxed on the profits. However, those I’ve spoken to across the Tasman tell me that this tax is, for the most part, ignored. The NZ Inland Revenue Department finds it very difficult to establish the intent at the time of purchase.
So, enjoy your free ride Kiwis!
Oh, and if you’re wondering if you can still live here in Australia and avoid CGT by investing across the Tasman, I’m sorry to say the answer is no. According to the ATO, “As an Australian resident, you are generally taxed on any capital gains you make on an overseas asset and must report the gain in your tax return.”
5. Rent Out Your Personal Residence Temporarily.
As I already mentioned, your principal place of residence (PPOR) is not subject to CGT upon sale. Is there a way to earn rent from your PPOR while maintaining its tax-sheltered status?
The answer is yes. The ATO understands that sometimes Aussies may need to live elsewhere temporarily.
As long as you’ve already lived in your home for a reasonable period, perhaps six months or more, you will have up to six years before this property will become subject to the CGT. The primary caveat is that you must not live in another home that you own during this period.
Just keep in mind, technically, your PPOR was never an investment asset, even if you had a tenant living in it. Your home is a lifestyle asset and you should consider it as such.
6. Renovate Or Add An Extension To Your PPOR Before You Sell.
Again, your PPOR is not an investment property, but I thought this was worth mentioning. If you add value to your PPOR before selling it, that profit is not subject to the CGT.
7. You Could Buy A Property Through A Self Managed Super Fund (SMSF)
There’s one last strategy worth mentioning. There are some CGT benefits for assets you purchase within your SMSF, but be sure to read Steve’s warning here.
Here’s the bottom line: If you sell your property once you’ve retired and are in the “pension phase,” you don’t have to pay any capital gains on your profits.
Even if you sold the property during “accumulation phase,” this profit is taxed at a rate of only 15 percent, or 10 percent if you have held the property for more than a year.
Buying a property within your SMSF comes with some risks. It’s quite complex, so be sure to first seek professional advice before heading down this path. Besides, if you’re young and you have big goals, why would you want to wait until you’re 60 to enjoy the fruits of your labour?
Perhaps it’s best to just accept life’s two great certainties:
- You will die.
- You will pay taxes.