Yahoo Finance Capital gains tax warning to Aussie investors missing out on $150,000 cash boost
Finance expert Ben Nash has revealed the ways you can avoid being stung when you sell up.
Selling an investment property can deliver a big windfall, but also has some big tax consequences attached. Making tens or hundreds of thousands of dollars is obviously a good thing, but if a large chunk is going out through your tax bill, it means less profit for you to save, invest, or use to fund your lifestyle.
But if you’re smart with your planning, it’s possible to sell a property entirely capital gains tax-free. There are three key strategies worth looking at to cut your tax bill when selling an investment property.
Superannuation is your friend
Under the current rules, you can make tax-deductible contributions to your super fund of $30,000 each year.
Further, if your super balance is below $500,000 and you haven’t ‘used up’ your super contribution limits from the last five financial years, you can ‘catch up’ on these unused contributions to make five years’ worth of tax deductible super contributions in one year.
It’s worth noting your annual super contribution limit includes any money contributed to your super fund by your employer, but for most people, this leaves a fair bit of room for some serious contributions (and serious tax deductions).
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Using the catch-up super rules, you have the ability to make super contributions of up to $132,500 on top of your contribution limit for this current financial year, meaning you can make total contributions of $162,500 - being $132,500 in catch-up contributions plus this year’s $30,000 limit.
BREAK IT DOWN: Consider this example. You sell an investment property for $800,000 that was purchased a few years ago for $500,000.
In this case, your capital gain on the sale of the property would be $300,000 ($800,000 sale price less $500,000 purchase price).
Because you’ve held this investment for more than 12 months, you would access the 12-month long-term capital gains tax discounted rate of 50 per cent of the gain.
This in turn reduces your taxable capital gain to $150,000 ($300,000 gain at 50 per cent discount).
If you were to then make a super contribution and use the catch-up super contribution rules, contributing $150,000 to your super fund would effectively reduce your taxable gain to $0 - meaning no CGT would be payable on the sale.
Superannuation may not be the first strategy you think of when it comes to what to do with a lump sum injection of cash from selling an investment property.
And you should be mindful that any money you put into superannuation will effectively be stuck there until you reach retirement age.
That being said, if it’s a matter of choosing between putting money into super or paying it to the ATO in the form of a tax bill, my personal preference would be to tax the tax savings and build my super fund investments.
Using family trusts
Family trusts (or discretionary trusts) have the ability to own investments like property, and can deliver some serious tax savings when it comes time to sell a property.
This comes from one of the main trust rules which allows you to stream trust income (including capital gains) to multiple taxpayers.
Because marginal tax rates increase as your income increases, spreading capital gains income across multiple taxpayers will create tax savings.
BREAK IT DOWN: For example, every person in Australia has the ability to earn $18,200 each year without paying a single dollar in tax.
This means that if you owned a property inside a trust, you could distribute taxable gains to multiple people, and if they didn’t have other income they could receive $18,200 without paying a single dollar in tax.
Even if you don’t have enough people to stream income to that will get your tax down to zero, paying to two or more people will result in paying a lot less tax than one person receiving the full gain and likely paying tax at the highest marginal tax rate.
When it comes to using trusts to save tax, it’s worth noting that you can’t move a property into a trust after it has increased in value without tax consequences.
This is why it’s important to plan smart before you start buying up investments.
Leverage negative gearing
If you have extra income from selling an investment property, cranking up your tax deductions can help to push down your taxable income, and push down your tax bill along with it.
Negative gearing, or borrowing money to buy an investment property will generally give you tens of thousands of dollars in tax deductions, potentially saving you tens of thousands of dollars in tax.
BREAK IT DOWN: For example, buying a $1 million investment property will cost you around $65,000 in interest costs at the current average mortgage interest rate of 6.5 per cent.
On top, you’ll have costs like strata and rates, maintenance, and insurance which typically average out around 1 per cent of the value of a property.
This means a $1 million property would have attached costs of $10,000 p.a.
This brings the total costs of your property to $75,000 p.a., and under the negative gearing rules this $75,000 is fully tax deductible - this can help to offset any capital gains tax bill.
If you’re thinking about going down this path, there are two things to be mindful of.
First is your risk management, because borrowing to invest does come with risk that’s important to manage.
The second is the fact that negative gearing means you’re losing money from a cashflow perspective.
When you choose a good investment property, this loss will be balanced out (and exceeded) by the growth in your property over time - but it’s important you choose a property that will actually grow.
Because while tax deductions are great, if your investment isn’t delivering a return overall you’ll end up behind.
The wrap
Selling an investment property is a huge opportunity to accelerate your wealth building and progress toward financial independence, but the more tax you pay, the less money you have leftover to actually use to get ahead.
If you’re paying tax it means you’re making money, which is definitely a good thing.
But you don’t want to pay more than you have to, and if you’re smart about how you use the rules to your advantage you don’t have to - there are some serious savings up for grabs.
Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth. Ben’s new book, Virgin Millionaire; the step-by-step guide to your first million and beyond is out now.
If you want to review your existing mortgage and see how much money you can save, you can use our free mortgage comparison tool here.
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.
