Selling an investment property in Australia often raises concerns about Capital Gains Tax (CGT), an essential aspect of the property investment journey. While there’s a lot of discussion about reducing CGT liability and utilising the concessions and exemptions provided by the Australian Tax Office (ATO), there is relatively little conversation about situations where a property is sold at a loss.
It’s crucial for property investors to understand the other side of the coin – how a capital loss affects tax liabilities and overall financial strategies.
Is it possible to use Capital Losses as a tax planning tool to maximise the tax benefits associated with investment property transactions? Let’s explore this aspect, as there may be a silver lining to the dark and gloomy clouds surrounding a Capital Loss.
Understanding the Capital Gains Tax Framework
In Australia, Capital Gains Tax (CGT) is imposed on profits made from selling or exchanging a capital asset. Unlike a separate tax, CGT is treated as part of income tax, calculated at the individual’s marginal tax rate. It applies when a CGT event occurs – for example, when selling an investment property or shares. Essentially, a gain from a CGT event increases the taxable income. The Australian Taxation Office (ATO) administers CGT and provides guidance on its calculation and payment.
The amount of CGT owed depends on the difference between the asset’s cost base (initial cost plus additional expenses 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.
Click here to learn more about CGT.
CGT Discounts and Exemptions
In most cases where you make a 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.
Turning a Capital Loss into an Opportunity
When discussing investment property in Australia, most investors are aware of the necessity to pay capital gains tax (CGT) when they realise a profit upon selling their property. However, what happens if they incur a loss?
A capital loss transpires when the sale price of an investment property falls below the original purchase price. This indicates a financial loss incurred upon the property’s sale. While this situation may seem unfavourable, there are strategies to mitigate the impact of such a loss.
Firstly, if a capital loss is incurred, there is no CGT payable, as losses are not subject to taxation. In fact, capital losses can be utilised to offset capital gains from the sale of other assets. This entails deducting the capital loss amount from any other capital gains achieved within the same financial year, thus leading to a reduced overall capital gains tax liability.
Carrying Forward Unused Capital Losses
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 income from alternative sources, 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.
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 demand in the region. 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 any 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 acquired a property constructed in 2015, which had functioned as a rental property since its inception. Being aware of diverse investment strategies and tax intricacies, Jessica engaged the expertise of Duo Tax to establish a Tax Depreciation Schedule immediately after the purchase.
Following changes to Australian tax laws in 2017, depreciation on second-hand assets ceased to be claimable. Since Jessica’s property predates her acquisition, all assets within were deemed ‘second-hand.’ However, this limitation did not preclude leveraging the depreciating value of these assets.
Duo Tax, recognising this situation, furnished Jessica with a capital loss report attached to the tax depreciation schedule. This report lucidly depicted the diminishing value of the second-hand assets for each financial year.
Fast forward to 2023, Jessica decided to upgrade the property’s air conditioning system from a split system to a modern ducted system. As per the capital loss report by Duo Tax, the residual value of the split system air conditioning unit stood at $800.
Jessica’s foresight began yielding dividends at this point. By removing the split system unit and thereby eliminating its residual value, 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. Nevertheless, owing to the capital loss arising from the air conditioning unit’s removal, 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 astute decisions did not cease there. By substituting the outdated air conditioning unit with a modern ducted system, she also enhanced the property. This enhancement allowed her to claim depreciation on the new unit’s cost, encompassing installation expenses, further diminishing her tax liability.
This illustration underscores how Jessica converted what initially appeared to be a drawback – the inability to claim depreciation on second-hand assets – into an opportunity.
Please note that some terms and phrases may have been modified to adhere to Australian spelling conventions. If you require further adjustments or clarifications, please don’t hesitate to ask!
Seeking Professional Advice
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, akin to the situations faced by Sean and Jessica, we may have the opportunity to employ this loss to offset any capital gains derived from other investments in the ongoing financial year or, alternatively, carry it forward for offsetting future gains.
A tax advisor can ensure that our reporting accurately reflects our capital losses and exemptions. It is also crucial to remain vigilant regarding any alterations in laws and regulations that could impact our investments. Collaborating closely with a proficient tax specialist can ensure that we remain well-informed and updated on pertinent modifications and their potential repercussions on the sale of our investment property.
- 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 optimal utilisation 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.