Are you confused about Capital Gains Tax (CGT) and Goods and Services Tax (GST)? This article explains how they apply to property.
Though the property market is undergoing a rough patch in 2019, it’s generally seen a boom over the last few years.
This has led to many people becoming interested in investment and development. There are all sorts of ways to enter the market. You may invest in a property with the intention of generating revenue and selling it on later.
Or, you may own a property that’s of interest to a developer. This could lead to you selling for much higher than you might sell to the regular market. In some cases, groups of property owners band together to sell multiple properties to the same developer.
The Tax Question
The key question that many have is how tax applies to such transactions.
The ATO may consider profits from such transactions as ordinary business income. This could be the case even if you don’t consider investment or development as your main income source.
Specifically, you may have to pay income tax in the following cases:
You entered into the transaction with the express purpose of making a profit.
You made a profit as a result of a commercial transaction or business operation related to the transaction.
This brings us to the subject of CGT and GST. Both may apply to your property transaction. As a result, it’s important that you understand each. And more specifically, you must know how to calculate CGT to see its impact on the transaction.
GST and CGT Simplified
How does each type of tax relate to property?
In the case of GST, we can look to the decision of the Full Federal Court in the case of Sunchen Pty Ltd v FC of T11. This defines what the buyer needs to remit GST in a residential property purchase.
This examined the sale of residential properties and how GST applies in such circumstances. The decision rules that nothing but the property’s physical characteristics were applicable in terms of GST.
This defines what a buyer may have to pay GST on.
You have to remit all GST payable on a property purchase directly to the ATO. This applies for the purchase of possible residential land and the purchase of any new residential property.
CGT applies to the seller.
It’s a tax that you have to pay whenever you sell an asset, such as property. It applies to any property that you bought after, or on, 20th September 1985.
If there’s a contract involved, such as with a property sale, you calculate CGT based on the date on the contract. If there’s no contract involved, you calculate it based on when you no longer act as the asset’s owner.
In property, CGT applies to any profit made above the costs of buying and maintaining the property.
Calculating Capital Gains Tax
GST applies at a standard rate of 10%. As such, you don’t need to worry about calculating it too much.
CGT is a little different as there are several possible exemptions and changes that you can make.
Calculating Your Capital Gain
First, let’s look at how to calculate your Capital Gain.
Start by using the following equation to determine your Cost Base:
(Purchase Price + Costs Related to the Property) – (Depreciation Claimed + First Home Owners Grant (FHOG))
The FHOG won’t apply in all cases, so you can ignore that part of the equation if you didn’t use it.
Now that you have your Cost Base, you can work out your Capital Gain using the following equation:
Price of Sale – Cost Base
You now have a Capital Gain figure to work with.
The Basic Taxes
How much CGT you pay on this figure depends on several factors. These include when you sold and if you’re operating a business. Here are the basics:
If you’re selling the property as part of business operations, you pay 30% CGT.
As an individual, your capital gain simply gets added to your income if you sell the property within a year of taking ownership. This means you pay tax on it at your marginal income tax rate.
If the property is an asset held by a Self-Managed Super Fund (SMSF), you discount 33.3% from your Capital Gain. You then pay a CGT of 15% on the new figure.
But what happens if you’re an individual who’s selling a property that you’ve owned for more than one year?
In this case, you may have a choice of two methods:
- Indexation Method
- Discount Method
Let’s look at each individually.
You may only use this method if you bought the property prior to 11.45am (ACT time) on 21st September 1999.
This method allows you to increase your Cost Base. You do this using an indexation factor from the Consumer Price Index (CPI). However, this factor may not relate to any period after September 1999.
This method involved a complex calculation that gives you a multiplier to apply to your Cost Base. It’s best to work with a tax professional for this. However, the end result is usually a higher Cost Base. This means your Capital Gain decreases, so you pay less tax.
This is the much simpler method of the two.
In this case, you receive a 50% discount on your Capital Gain. So, simply divide your Capital Gain by 2 to get the figure that you need to pay CGT on.
Either method leaves you with a new Capital Gain figure. From there, the money gets added to your income and taxed based on your marginal rate.
There’s More to Learn…
This covers the basics of how GST and CGT may apply to your property purchase.
However, there’s much more to learn. For example, you may be able to achieve full or partial exemption from CGT based on a number of circumstances.
Bottrell Business Consultants would like to help you to minimise your tax liability for your transaction. To find out how we can help, call us on 02 49 336 888 to book a free consultation.