If you’ve ever sold a commercial property, you’d likely know the sweet taste of profit. But you’d also know the bitterness of giving some of that hard-earned return to the taxman. Capital Gains Tax (CGT) is a levy no commercial property investor looks forward to, but there are ways to mitigate it. The key is understanding how.
Here we’ll help build your understanding of capital gains tax on commercial property investment, so you can minimise the tax obligations and retain the wealth from your next divestment.
A capital gain, or capital loss, is the difference between the purchase price of your commercial property investment, including improvement costs, and the amount received when sold. If the sale proceeds are higher than the preceding outlays, this profit has capital gains tax applied.
To optimise your tax position when selling a commercial property, you might first consider whether you buy it as an individual or in a trust, superannuation fund or company name. As you’ll see, your future tax position will likely be different depending which entity holds and sells the asset.
If you’re selling a property as an individual, CGT isn’t applied at a specific tax rate. Rather, it’s calculated based on your personal marginal tax rate for that particular year. A company which sells a commercial property will have a flat 30 per cent CGT rate, and a trust or super fund will distribute its property’s capital gain to trustees. The trustee’s appropriate tax rate will then be applied.
But calculating CGT doesn’t end there. Investors should consider the discounts available to protect their profit from tax erosion.
A commercial property investment held for more than 12 months is eligible to have its capital gain liability reduced by 50 per cent for an individual taxpayer or by 33.3 per cent for a super fund. This is called the discount method of reducing CGT, which unfortunately companies aren’t privileged to.
If bought under a company name, you can at least find peace knowing your property’s capital gain will be taxed at the 30 per cent corporate tax rate, which is a lot less than the highest marginal rate for individuals. To protect their return further, some companies then claim franking credits on company dividends paid from the property’s after-tax profits.
For self-managed super fund members, if a property is held in your SMSF for over 12 months, you only pay 10 per cent on capital gains. And when a member of the fund reaches the age of 60 and retires or reaches the age of 65, any income received will be tax-free.
If your asset has been held for less than 12 months before you sell it, there’s still good news for your CGT obligations, which can be reduced by claiming certain deductions.
The greater the costs to upgrade and improve the property (known as the cost base), the less CGT you’re likely to pay.
The ATO says the cost base of a CGT asset is made up of a few elements:
You should retain records and receipts of every expense made to improve your asset, from the date you bought it. You could then use them to bolster your cost base and reduce your capital gains tax.
The theme here is that preparation is key before a CGT event. Savvy investors will understand their likely tax obligation on the sale well in advance, because this gives them time to prepare and perhaps set aside funds to cover the projected amount owed. So, before you sell your property, use your forecasted sale price and cost base to find out your expected capital gains tax.
For those who’ve played the long game and still own a commercial property purchased before 20 September 1985, you won’t pay any capital gains tax. This is the date CGT was introduced by the Hawke/Keating government, who abstained from making the tax retrospective.
Keep in mind though, capital gains from improvements made since this date will be subject to CGT (even if purchased before 20 September 1985).
Should the amount you receive when selling your property be less than your cost base, you have a capital loss. A loss on a commercial property investment bears one benefit, that it can be carried forward to future tax returns and deducted from any capital gains. Capital losses made by a trust can’t be distributed to beneficiaries or unit holders but can be carried forward to reduce capital gains in the trust’s future years.
Tax payers should also take note that capital gains can be netted of any normal income losses in the same tax period. But capital losses can’t be offset against normal income.
The ATO says that a CGT event occurs when a property is contracted for sale – not the date of the sale, known as the settlement date.
So, investors should consider the timing of their property sale, because contracting the property for sale this financial year or next might have a big difference in calculating your tax liability. As with any major tax event, it’s smart to run these matters by your accountant first.
Don’t let the taxman reduce you and your family’s wealth. A better understanding of CGT will help you make more informed decisions on when and how to sell an asset. Knowing how to calculate and apply discounts to capital gains tax, and importantly how to minimise it, means more profit in your pocket.