In simple terms, capital gains tax applies to a capital gain earned upon sale of an asset, such as an investment property, which was acquired on or after 20 September 1985. There is a capital gain if the proceeds from the disposal are more than the cost of the asset.
The cost of an asset is calculated in a special way. It is permissible to include legal costs and other incidental costs incurred in its acquisition, for example, stamp duty. In some circumstances your client may also be able to include certain other non-capital costs such as some finance costs, rates or land tax.
There are other rules that can modify the cost base of an asset.
Capital gains and capital losses arising for a taxpayer in an income year form part of the calculation of a net capital gain or net capital loss. The net capital gain then is incorporated into a taxpayer’s taxable income in the same manner as any other income.
The most important exemption from capital gains tax is the main residence exemption. An individual can ignore a capital gain from the sale of their main residence. The basic rule is that the main residence exemption is available if the dwelling is an individual’s home for the whole period during which it is owned, the dwelling was not used to produce assessable income and any land on which the dwelling is situated is two hectares or less.
However, there are rules that can extend and also limit the main residence exemption in certain circumstances. For example, a person can be absent from their main residence for up to six years and rent it out during the absence and still qualify for the exemption provided they resume living in the house before selling it, or sell it within the 6 years.
It should be noted that capital gains tax does not apply to someone who is in the business of buying and selling land, such as a land developer. In this case, any profits arising on disposal of the assets will be taxed as ordinary income. Factors to consider in deciding whether someone is in the business of buying and selling real estate include the commercial character of the transactions and the scale on which the activities are conducted. A typical individual investor who purchases and later sells real estate will not be in the ‘business’ of buying and selling land and the capital gains tax provisions will apply.
The method used to calculate capital gains tax varies according to when the property was acquired.