Here at The Account Ant we've been discussing the infinite rabbit hole that is the share market. If you have recently taken the plunge and started to invest, or if you are thinking about it, you may have heard the term capital gains tax bandied about. Here I am going to discuss everything you need to know about Capital Gains Tax. And to be honest, probably a bit more than you want to know. Let's dive in.
What are capital gains?
A capital gain refers to the increasing value of an asset and is usually calculated when the asset is sold. For example, you buy a star wars figurine for $10,000, then sell it two years later for $12,000. The $2000 you made on the sale is a capital gain.
What is the difference between capital gains and equity?
Capital gains refers to the increase in the value of your asset, whereas equity refers to the amount you own vs the amount that is still under finance. So if you bought a house for $200,000 and it is worth $300,000 today, you have made a $100,000 capital gain. If you owe $100,000 on the same house, your equity is $200,000. If you were then to sell that house, $100,000 from your $200,000 equity would pay out the amount owing on the loan, and you would be left with your $100,000 capital gain.
What is capital gains tax?
Capital gains tax is the tax you pay on growth in value of your investments when you sell them. Of course the government wants a piece of the piece when you make money in any way! When you sell any assets, the capital gains are referred to as having been realised. Therefore, you only pay capital gains tax on appreciating assets when you sell them. Unsold assets that have grown in value are referred to as having "unrealised capital gains."
What do I pay capital gains tax on?
There are a number of different asset types that you may have to pay capital gains tax on. These include, but are not limited to:
real estate
shares
cryptocurrency
collectibles
Capital gains tax on real estate
Most real estate is subject to capital gains tax. This includes holiday homes, vacant land, business premises and rental properties. However, if you are selling your main residence, you don't have to worry about paying capital gains tax, unless it is on more than 2 hectares of land or you have used to it run a business.
Capital gains tax on shares
Capital gains tax is applicable to most shares. It is only applicable when you sell your shares, and is payable in the same financial year as the sale.
Capital gains tax on Cryptocurrency
Many people, particularly millennials, are choosing to invest in cryptocurrency as a way to make money. Day trading, or short term trading may seem like an appealing option. This is especially the case with the huge fluctuation in price. So what does that mean when it comes to tax time?
Basically, any profits you make from trading cryptocurrency will be added to your taxable income at the end of the year. You will then pay tax on your gains depending on what tax bracket you fall into. So if you are earning between $45k $120k (as most of us are) you will pay 32.5% tax on that income. That may not seem like such a big deal, but if you are earning more than $1000 from your trading activity (congratulations) it will start to make an impact.
I have two pieces of advice. Firstly, put aside some of your earnings in case you end up with a tax bill. Secondly, if you hold onto your cryptocurrency for over 1 year, you get a 50% discount on you capital gains tax. So rather than paying 32.5% you will pay 16.25%. When you are looking at selling you need to weigh up which makes sense financially. If you are selling after a huge spike in price, you may decide it is worth paying the full amount of tax.
Capital gains tax on collectibles
Capital gains tax must be paid on collectibles that are bought for over $500. This includes things such as artwork, jewellery, antiques, coins or stamps. It may also include your beloved Star Wars memorabilia still in the box. However, if you acquired the collectible for less than $500, you are exempt from paying capital gains tax.
Capital gains tax exemptions
Your main residence, your car, personal use items and collectibles under $500 are all exempt from capital gains tax. Assets acquired before 1985 are also exempt, as they were purchased before capital gains tax law was enacted. Finally, depreciating assets such as business equipment and fittings in a rental property are also exempt.
When do I have to pay capital gains tax?
Capital is paid when you submit your tax return. Capital gains tax must be paid in the financial year that an asset is sold. When you submit your tax return you report your capital gains and losses and capital gains are counted toward your taxable income.
How is capital gains tax calculated?
The first step to calculating capital gains tax is to work out your net capital gain. Do this by taking the sale price and subtracting the cost price and any costs associated with obtaining and managing the asset
Capital gain = sale price of asset - cost of asset - associated costs
For example, Abigail just sold 20 dogecoins for $400 total. She bought them for $200 6 months ago, and paid $10 in fees through her Cryptocurrency app. Her capital gains are $190.
Things get a bit more complicated when selling larger assets like real estate, as there are a lot more costs associated. These can be things such as:
costs of transfer
stamp duty
borrowing expenses such as mortgage application fee
advertising costs
valuation fees
conveyancing fees
real estate agent fees
Just remember, if you are selling your primary residence you don't need to worry about capital gains tax.
Capital gains tax rates Australia
Capital gains are added to your taxable income for the financial year that the asset is sold. So in most cases you will be taxed at the marginal rate for your income bracket. Below are the income tax brackets for Australia in 2020-21. These can be used to estimate your capital gains tax.
There are a few exceptions to take into consideration about capital gain tax.
Companies are not entitled to any capital gains tax, so if the property has been used as a place of business, you’ll pay 30% tax on any net capital gains.
For self-managed super funds, the tax rate is 15% and the discount is 33.3%.
If you have held the asset for over a year you can get a 50% discount on capital gains tax.
How do I pay less capital gains tax?
Individuals and small business can discount a capital gain by 50% if the asset is held for more than a year. So the first step to reducing your capital gains tax is to favour long term investments over short term.
The next way to reduce your capital gains tax is to reduce your taxable income via deductions. Make sure you claim every deduction that you can. If you plan to make a big purchase that is claimable on tax, try and do it in the same financial year as the sale of your asset.
The Bottom Line
Capital gains tax may seem painful, but at the end of the day, you are paying it because you have made a profit! So you can think of it as a happy tax! If you want to minimise your capital gains tax, focus on long term investments and make sure you claim everything you can!
Happy investing!