Capital Gains Tax (CGT)

If an individual sells an investment that they own and the sale price is higher than the purchase price (i.e they receive a profit or a gain) then that individual has made what is known as a capital gain. Conversely, if an individual sells an investment that they own and the sale price is lower than the purchase price (i.e. they have made a loss) then that individual has made what is known as a capital loss.

Capital gains and capital losses are a very common occurrence in the world of investing, trading, and property. Very rarely does an individual sell an investment that they own for the exact same purchase price. The unlikely nature of this happening will lead to an individual making neither a capital gain or a capital loss.

Capital gains tax (CGT)

CGT is a tax which most individuals will incur if they have made a capital gain selling an investment. This tax is not an income tax despite this tax being added to an individuals income.

• CGT assets: Before determining whether you will receive a capital gains tax, you need to determine whether the asset you own is a CGT asset. The sale of certain assets you own does not always mean you will receive a capital gains tax, certain assets will not incur any CGT despite you making a capital gain on them such as any personal assets (the property you live in, the car you own, furniture etc).
• CGT event: The common term for either receiving a capital gain or a capital loss is what is known as a CGT event. In most scenarios, the date of the CGT event is when the asset that is being sold has changed ownership. However, if there is a contract involved in the sale of the asset then the date when you legally enter the contract is when the CGT event happens. Timing is critical for a CGT event, it can have a consequential impact on the amount of tax that has to be paid if timing is not properly understood.

Similar to the timing of a CGT event, having a clear grasp of what types of CGT events there are is very beneficial as it can avoid any confusion during your tax return. Although for most individuals a CGT event is simply the disposal or transfer of an asset from one individual to the other, it is important to understand that a CGT event is not just limited to a disposal of an asset. Compensation payments, capital distributions from a mutual fund or even the loss of a CGT asset are all classified as CGT events. As with many areas of tax, the different types of CGT events are varying in their forms and can be difficult to properly understand.

It may seem that paying CGT is inevitable if you have made a capital gain. There are some situations and certain events where it is possible to defer the CGT that you may have to pay through either an exemption, rollover or a concession.

• Exemption: certain assets can be entirely exempt from any CGT if they fall under certain classes. The home that you live in, any cars that you own, other personal assets etc. If these are the assets that you own and you make either a capital gain or a capital loss then you are not required to pay CGT, nor are you able to offset any future capital gains if you make a capital loss.
• Rollover: in particular instances you are able to rollover any capital gains you may have made until the next CGT event occurs. Such examples include demergers, destruction or loss of assets, asset transfers due to relationship breakdown and more. Unlike exemptions, in a rollover the next CGT event could potentially lead to CGT being paid.
• Small business CGT concession: a small business CGT concession is another way CGT can be exempt or rolled over if a CGT event occurs. With this there are many different rules and regulations that need to be followed and several different methods that can be used.

Capital gain or capital loss

Once you have properly understood if you own a CGT asset and whether a CGT event has occurred, your next step is to determine whether you have made a capital gain, a capital loss and then you need to determine your net capital gain or net capital loss. Working out your capital gain is a bit more complicated than your capital loss. To work out your capital loss you simply have to subtract your reduced cost base from your the proceeds you receive from the sale of the asset and that is your capital loss. If the final value is negative you have made a capital loss.

To work out your capital gain there are three different methods where only one can be used: the CGT discount method, the indexation method and the other basic method. The correct method to use is based entirely on when the asset was acquired and how long it has been held for. The ATO website goes through this in detail.

Regardless of the situation, all investors would try and avoid a receiving a capital loss. A capital loss essentially means that the individual has lost money on selling that particular CGT asset, hence for obvious reasons it is not favourable. However, individuals are not required to pay any taxes on capital losses. Additionally, if a capital loss is made overall for an individual and the end of the financial year then that individual is able to carry forward those capital losses to future years to offset any capital gains made reducing the CGT they have to pay in that financial year.

For example, if an individual has made a net capital loss of $10,000 in the 2015 financial year and has made a net capital gain of $25,000 in the 2016 financial year then the amount of CGT that has to be paid in the 2016 financial year is only applicable to the amount of $15,000 ($25,000 - $10,000). Although capital losses are not ideal, they can potentially offset any capital gains made in future years resulting in less CGT being paid.

Working out the capital gain or capital loss you may have made is not as difficult as it seems. However, getting to that final step can be quite daunting. Determining whether you have a CGT asset, keeping records, verifying a CGT event, calculating your capital loss or capital gain and working out whether you are eligible for an exemption, rollover or a concession are all just what make up the spine of CGT. There are many more in depth points to consider if you are in a position which may require you to pay CGT or may result in a capital loss.

Instead of trying to go about all this all by yourself, Sydney tax accountants for working professionals and small businesses iTrust Tax and Accounting are here to assist you with any general tax and specific CGT advice you may require. Furthermore, depending on your situationwe may be able to provide specific advice on how you may be able to avoid CGT through various structures such as family trusts, SMSF etc.

Your capital gains could be endless, with that comes much higher taxes. Partnering with the appropriate tax accountant could potentially save you thousands of dollars.

Rizwan Inayat is the Director of iTrust Tax and Accounting. He has over 10 years of experience in tax, accounting and financial services.