If you have sold an investment property, shares or other investment asset in the last financial year, you may be liable to pay capital gains tax (CGT).
Let’s understand how capital gains tax is calculated. In my experience, many people find this more complex than what is really is.
How to understand your capital gains tax liability
First, you need to calculate what is your capital gain. This is the sale price less your purchase price and any capitalised expenses. For example, when calculating your capital gain on an investment property, your purchase price can then have a number of expenses added to calculate what is called your ‘cost base’. This includes expenses such as stamp duty, legal fees and purchase costs when the property was first bought.
Secondly, do you qualify for the capital gains tax 50% discount? If you have held the asset for more than 12 months, you will be able to choose one of two methods to determine how much capital gains tax is payable. In this case, 50% of the assessable capital gain will be included in your taxable income. The second method is called the indexation method. The indexation method is slightly more complex and you should seek tax advice if this method is to be considered.
Thirdly, what will your marginal tax rate be? Many people are mistaken in thinking there is a separate tax rate for capital gains tax compared to personal income tax. This is not the case. With an assessable capital gain, it is simply added to your other personal income from wages and other sources.
For example, if you earn $80,000 per annum from wages and $5,000 from dividends, your normal assessable income is $85,000. If this financial year you sold an investment property for $700,000 that has a cost base of $400,000, the $300,000 gain qualifies for the 50% discount, therefore the $150,000 taxable gain is then added to your ordinary income. Thus, $85,000 plus $150,000 equates to a taxable income of $235,000. You now have the honour of jumping from the 32.5% marginal tax rate threshold to the 45% marginal tax rate threshold plus the 2% Medicare Levy.
Once you know your capital gains tax liability, these three quick strategies may help to reduce your capital gains tax bill.
1. Make some additional concessional contributions to super
You can opt to make a personal deductible superannuation contribution to your superannuation fund. These are only taxed at 15% (or 30% if your taxable income is over $250,000). It is important to keep in mind that you cannot exceed the concessional contributions cap of $25,000 for the 2020/2021 financial year (this cap increases to $27,500 after the 1 July 2021). Your concessional contributions cap also includes any contributions made by your employer or a salary sacrifice arrangement.
Although this is a great strategy, one needs to weigh up that any contributions cannot be used for personal purposes until you have retired.
2. Prepay interest expenses for next year
If you have any expenses that you can pre-pay, this will help to offset the capital gains tax liability in the year the liability has been incurred.
For example, if you have some capital gains resulting from the sale of shares, and you own an investment property, pre-paying next year’s interest on your loan prior to 30 June means you can offset the capital gain in this financial year.
The downside of this strategy is that in the next financial year you will not be able to claim the expense as you cannot claim it twice. This strategy may be appropriate if the sale of an asset with a large capital gain in the current financial year has pushed you into a higher marginal tax rate bracket.
3. Prepay your advice expenses
Another idea is to speak with your accountant or financial adviser and ask if you can prepay their fees in a year that you need to offset a capital gains tax liability. I have offered this to a few clients with a 10% discount.
There are several more complex strategies that may be available to some people based on their personal circumstances.
It is always wise to seek advice from your financial adviser or accountant early so that you have enough time to prepare and implement any strategies prior to 30 June.
Andrew Zbik
Senior Financial Adviser
Creation Wealth
M: 0422 038 253
andrew.zbik@creationwealth.com.au
www.creationwealth.com.au