Encik G the NT Ambassador is a multiple property owner. So there is no one better to seek for wisdom if I want to know anything about investment properties. At the same time I read investment properties is liable to "capital gain tax of 50%" now and then got really frightened off by it. Anyone would. Come on, who wants to get taxed 50% of your profit, right?
After doing some (hours of ) reading at the bloody ATO website, I came to realise it doesn't work like I feared. Well, we still get taxed but it isn't as bad as I initially thought and there are ways to reduce it. First, let's get the Capital Gain Tax (CGT) straightened out.
Step 1: To calculate Capital Gain (or loss),
CG = Sold Price - Buy price - All Cost (includes stamp duty, insurance, purchase and selling cost etc etc)
In short, CG = Net profit in business terms. Good thing we can include costs in the capital gain calculations instead of absorbing it painfully.
Step 2: To determine Taxable Capital Gains (TCG)
TCG = CG x 50%
This is what confuses me (and others) initially. Then I found out that the TCG is not what we are paying to the tax office. Rather it is the amount taxable after a "50% discount" (for houses held for at least 1 year).
Step 3: To determine Capital Gain Tax (CGT)
CGT = (marginal tax rate x TCG)
where marginal tax rate is determined by adding CGT to your annual taxable income, which will inevitably increase your tax bracket. Which also mean the best time to sell an IP is when you are unemployed. (I'll write a separate post on that)
Worked example:
A chap like you with an annual income of $70,000. Your effective tax rate will be 20.42% based on the progressive tax bracket system, and you would have paid $14,297 in tax.
Calculation:
[$3572 + (.325 x (70k-37k))] = $14,297
$14 297 / $70k = 20.42%
You owned an investment property bought at $450,000 a few years ago and decided to sell it this year at $550,000. (For simplicity's sake we will omit all costs involved, as well as other sources of income like such as rental).
Capital gain = 550,000 - 450,000 = 100,000
Taxable Capital gain = 100,000 x 50% = 50,000
Taxable income tax for the year = Annual Income + TCG = 70,000 + 50,000 = 120,000
The increase of your taxable income tax from $70,000 to $120,000 will move you to the next tax bracket between $80k to $180k. This means you will be taxed:
The first $18,200 – Tax free
$18,200 to $37,000 – 19%
$37,000 - $80,000 – 32.5%
$80,000 - $120,000 – 37%
Which adds up to $32,257 in tax, and an effective income tax rate of 26.88% after accounting for your capital gains.
Effectively, the extra $50,000 of taxable income will be taxed at:
First $10,000 – 32.5%
Next $40,000 – 37%
Therefore, your Capital Gain Tax = $32,257-$14,297 = $17,690 (You pay the ATO)
And your net capital gain will be $100,000 - $17,690 = $82,040 (You keep this as your gains)
(not $50,000 gain, and $50,000 tax as many of us thought so)
Still painful but not as painful as we thought. It depends on your original income – the more you earn, the more you get taxed on the additional income. If you haven’t realised, the Capital Gains Tax is actually more favourable than getting taxed as ordinary income because you get a ½ price discount, so capital gains tax only applies if you sell your property after 12 months and it is deemed to be a capital gain – another story for another time.