Capital Gains

Capital gains tax (CGT) is one of the most significant taxes affecting investment returns. Understanding and implementing effective CGT strategies can save thousands of dollars and significantly improve after-tax returns.

This comprehensive guide covers all aspects of capital gains tax, from basic concepts to advanced strategies including parcel apportionment, cost base adjustments, the CGT discount, loss management, principal place of residence rules, and mixed-use asset considerations.

Mastering these strategies requires understanding the rules, timing considerations, and how different approaches can be combined for maximum tax efficiency.

Parcel Apportionment

Parcel apportionment is a tax deferral strategy that allows you to choose which purchase parcel of shares or units to sell. While you'll eventually pay tax on the total gain from purchase to sale price, choosing which parcel is sold can increase or decrease your tax owing for that year.

In general, you want to delay tax payments to maximize the time value of money. However, if you have a low-income year with unused tax brackets, you might want to realize higher gains to utilize those brackets and save lower-gain parcels for future years.

Parcel Apportionment Methods

• Average Price: Uses average cost across all parcels
• FIFO (First In, First Out): Sells oldest shares first
• LIFO (Last In, First Out): Sells newest shares first
• Low Cost First: Sells shares with lowest purchase price first
• High Cost First: Sells shares with highest purchase price first

Cost Base Adjustments

The capital gains on an asset is the difference between the cost base and the selling proceeds.

Cost Base is the buy price plus expenses related to purchasing (e.g., stamp duty, legal fees, brokerage, building reports), plus any cost base adjustments.

Selling Proceeds is the selling price less expenses related to the sale (e.g., agent fees, advertising, legal fees, marketing).

Cost base adjustments increase (or decrease) the effective buying price during the ownership of the asset.

Depreciation & Capital Works

Capital works increase the cost base of your asset (and thus reduce tax payable on sale), they are not a deductible expense.

Depreciation is the gradual deduction of capital works (both works you completed, and works completed by previous owners of the asset). This acts as both a deferral of tax, and a reduction of tax as the capital gain can utilise the CGT discount. However there can be a downside as usually the capital gain occurs all in one year so you're faced with higher marginal tax rate in that year. If you're earning over $45k taxable income there is no downside.

AMIT Cost Base Adjustments

ETFs and managed funds distribute earnings to unit holders, but they are not required to distribute the cash at the same time. If they distribute less cash than they should have this is classed as a shortfall and will increase your cost base. It has the same effect as dividend re-investment on your cost base without actually creating a new transaction. It's important that you retain every tax statement to use on your final cost base calculation.

CGT Discount - 12 Month Rule

The CGT discount provides a reduction in tax on capital gains for assets held longer than 12 months. The discount rate varies depending on the entity type holding the asset.

Assets must be held for more than 12 months from acquisition date to disposal date. The holding period starts from acquisition date and disposal date is when the contract is signed. Even one day short can cost you the discount.

This applies to assets acquired after 21 September 1999 and is one of the most valuable tax minimisation strategies available.

Because companies receive no discount, you can think of it as if they do, but their tax rate is double at 60%. As a result you would in general never distribute capital gains to a company which could receive the discount when distributed to an individual or trust.

Small Business CGT Concessions do receive a capital gain discount for active business assets (e.g. machinery) held for over 15 years.

CGT Losses

Capital losses can be used to offset capital gains before applying the CGT discount. When approaching end of financial year you can review your current asset valuations and consider selling loss position assets to reduce your tax for that year.

• Capital losses offset current year capital gains first
• Unused losses can be carried forward indefinitely
• Losses cannot be used to offset other income types
• Must be realized losses (not paper losses)
• Wash sale rules prevent artificial loss creation through quick buy/sell transactions

Mixed Use Home

When a property changes from private use to income-producing use, special rules apply to determine the cost base and potential CGT implications.

When you eventually sell it you can make one of three choices:

1. 6-year Rule: Use the 6 year rule to continue to class it as PPR, but means your other property cannot.
2. Basic: Time & Use Apportionment PPR vs Income Producing over the total gain
3. First Income: Time & Use apportionment PPR vs Income producing over the gain after the first time you generated income

You don't need to decide which method to use until you sell the property. However to be able to use the First Income rule you MUST get a valuation and records of similar house sales at that time from an agent or valuer. Therefore it is always best to get a valuation before you rent your home out for the first time. If you rent it out first you cannot use the first income rule.

Notice in the example that after you apply the first used to produce income rule the selling costs are completely deducted from the sale price. As a result if the gain that occurs in the year after moving out and renting the property does not exceed the selling costs, it is tax effective to do so.