So you made an investment, it went better than you thought, and now you want to sell out and take profits but are scared of the big tax bill lurking around the corner if you do. Well luckily there some strategies you can implement to help reduce your tax liability.
Now before I kick this one off, I do want to be clear that if you think one or more of these strategies might work for you then it’s best clarify with your accountant prior to proceeding. Tax can be a finicky beast with lots of moving components so get some professional advice.
What is capital gains tax (CGT)?
Put very simply, if you buy an asset and it goes up in value, you will have made a capital gain. The amount of gain is the difference between what you purchased the asset for and what it is currently worth.
If you then sell that asset, you will realise that gain and the ATO will want you to pay tax on in. This will form part of your assessable income. The higher your assessable income, the more tax you will pay as we have an increasing marginal tax rate in Australia. The tax that is paid on the gain is your CGT.
Now there are some intricacies around this. For example, certain expenses form part of your cost base to reduce the gain (such as brokerage). However, for the purpose of this blog, I just need you to understand the basics of what creates a capital gain and how it’s taxed.
Now let’s get to the meat of it – how do you reduce your CGT?
One of the best ways to reduce CGT is to plan for it before you invest. Put another way, structure your investments appropriately, whether that be investing in your personal name and using marginal tax rates or investing through a structure like a company, family trust, investment bond or super.
But if you are reading this, it probably means that you have already made the investment and are either on the cusp of selling it down or have already sold it. So, the opportunity to structure your assets appropriately has already passed.
Given this, let’s focus on what you can do assuming you have already made a purchase in your own name.
Hold the asset for a minimum of 12 months
One of the most obvious things you can do is hold the asset for a minimum of 12 months to access the 50% general discount. This will essentially halve the amount of assessable gain.
For example, if you purchased an investment for $100,000 and then later sell it for $110,000, you have made a $10,000 capital gain. If you haven’t held the asset for 12 months, you will be assessed on the full $10,000 gain. However, if you have held that asset for at least 12 months, the general discount will kick in, reducing the gain by 50% and therefore your assessable gain will only be $5,000.
Before selling down an asset, just check to see if you have met the 12-month qualifying period. If you haven’t, in some instances it might be worthwhile holding onto the asset a little longer to access the discount – provided you don’t think the price will tank of course!
A capital gain can be offset by a capital loss. This means that if you have sold an investment for less than what you paid for it, the loss on that investment can be used to reduce the gain on a different investment.
The process of tax-loss harvesting involves reviewing all your investments and selling out those that have made a loss to offset some of your gains.
Now obviously you are only going to sell out of an investment at a loss if you believe that the investment is unlikely to recover or if you have a better opportunity for the capital. You can’t sell out of the asset, realise the capital loss, then purchase it back again (essentially resetting the cost base) as this is known as a wash-sale and considered tax avoidance.
Pushing the sale into a new financial year
A capital gain will be taxed in the year that it is realised. Given this, it can be beneficial to plan which financial year you realise the gain.
For example, if you have a cracking year financially, earning lots of assessable income from work or other investments, then it might be worthwhile realising the gain in a future financial year. You would choose a year in which your marginal tax rate is lower.
For people on the cusp of retirement, this can be a great strategy. For example, if you want to sell an investment property to switch into more liquid assets for your retirement, you may want to hold off on making the sale until after you retire and you have no more earned income, so your marginal tax rate is very low. Just bear in mind, if you intend to use the proceeds to contribute to super, your working status might be important here.
This can also be a great strategy for self-employed people who either have very variable income or have the ability to retain earnings in a company to minimise their marginal tax rate.
Tax Deductible Super Contribution
One of my personal favourite ways to minimise your CGT is to offset the gain with a tax-deductible contribution into your super.
Subject to certain eligibility requirements, you may be able to contribute money into your super as a concessional contribution and claim a tax deduction by lodging a notice of intention to claim form. This tax deduction will reduce your assessable income and therefore reduce the tax payable on your capital gain.
Just be aware, there are cap limits on how much you can contribute to your super each financial year. Currently its $27,500 in the 2021/22 financial year however employer contributions will also form part of this cap limit.
I have released plenty of information in the past about how concessional contributions work so go back and read one of those if you are interested in the finer details.
Super is the only structure that will give you a tax deduction for investing for yourself which is why I like this strategy so much. The downside being you won’t be able to access that money until you meet a condition of release which, for most of us, is obtaining age 60.
Hopefully this gives you an overview of some ways in which you can reduce your CGT liability on an investment. If it is a business you are selling, then you may be eligible for the small business CGT discounts but that is a whole new topic for a different day.
Just remember, while it is good to reduce tax (legally) where you can, tax considerations are a byproduct of investing. The purpose of an investment should always be to increase your net asset position and if you have to pay some tax in order to do that then so be it.
In a perfect world, you would be planning for your CGT implications even before you make an investment.