When you sell an asset, whether as part of your business or in a personal capacity, it’s very easy to forget that there will probably be tax consequences, writes H&R Block (NYSE:HRB) director of tax communications Mark Chapman.
Maybe you’ve sold some shares or an investment property. Maybe your business has sold an office building or a valuable piece of plant. Maybe you’re looking at a life change and after building up your business, you’d like to sell it and do something else.
These are just a few examples of the sort of transactions which can generate a capital gain. Typically, the gain is calculated based on the difference between the money you make from selling an asset or investment and the price that you paid for it (less some costs).
The investments or assets that you sell could be property (for example, a building or block of land) but can also be shares in another company, units in a trust or a managed investment fund. An asset can also be intangible, such as contractual rights that the business has or even the goodwill of the business.
In addition, apart from selling assets, including land or buildings, Capital Gains Tax (CGT) can also be an issue if selling a part of the business, buying out a partner, making extensions to a factory or warehouse, altering your business structure (say by creating a trust and transferring the business assets into it) or receiving compensation for lost or destroyed assets.
There are always exceptions of course, and with CGT the principal exception is if the gain is also assessable under another part of the tax law, for example, if it qualifies as ordinary income. In this situation, the CGT rules take last place. As prime examples, sales of depreciating assets and trading stock are not taxed under the CGT rules because they have their own tax regimes.
Another common exception relates to the disposal of your family home. Provided the house you’re selling is your main residence – basically the house you live in on a daily basis – no CGT will arise when it’s sold.
How does CGT work?
CGT is triggered by a CGT 'event'. Typically, this happens when you sell an asset but can also happen if the asset is given away, if it's destroyed or lost, or you stop being an Australian resident.
CGT operates by taxing any increase in value from the time the asset was acquired or created. The capital gain is taxed in the year the asset is sold.
The amounts that are subject to tax vary, but the resulting capital gain is included with your income and taxed at whatever marginal rate you would then pay.
This is worked out by taking the money you make from selling the asset and subtracting your 'cost base'. This includes the price you paid, any costs incurred in buying and then selling it, and certain other incidental costs.
Also, if an asset was bought before September 1999, you may be able to increase the cost base by an 'indexation' factor, which adjusts the cost base so you're not paying tax on the inflation portion of the gain.
This amount is the gross capital gain. Next, take away any eligible capital losses. Finally, apply any applicable 'discount' factor (where the asset has been held for at least 12 months, you may be able to reduce the gain by 50% if you are an individual) to give the net gain.
Sometimes the tax law will require that the proceeds and cost base of the asset are not what was actually paid and/or received, but rather, the market value of the asset at that time. This is typically to prevent people from minimising their tax by, say, selling the asset to a relative for a low price.
Relief for small businesses
The special small business CGT concessions are in addition to the 50% general CGT discount applying to individuals, trusts and super funds (but not companies).
There are four CGT concessions that may be available to eliminate or reduce capital gains made by a small business or its owners where it disposes of “active” assets. "Active" assets include goodwill, trademarks and business premises but do not extend to passive assets such as an investment portfolio.
The reliefs are available to businesses which are small business entities (ie, they carry on a business and satisfy the $2 million turnover test) or where the net CGT assets of the taxpayer (plus its connected entities and affiliates) do not exceed $6 million:
1. The 15-year exemption.
Available where a taxpayer who is at least 55 years of age and is retiring disposes of a CGT asset that has been owned for a minimum of 15 years.
2. The retirement exemption
A taxpayer may apply capital proceeds from the disposal of a CGT asset to the retirement exemption, up to a lifetime maximum of $500,000 – as it is not necessary to actually retire, the concession can be used more than once.
3. The 50% active asset reduction
The capital gain arising from the disposal of a CGT asset may be discounted by 50%, but there are specific rules about what qualifies.
4. The CGT rollover
A capital gain arising from the disposal of a CGT asset may be deferred provided a replacement asset is acquired within a two-year period – the gain is deferred until disposal of the replacement asset.
And what if you make a loss?
It is possible to make a 'capital loss' if the money you realise from selling an investment is less than what you paid.
Unfortunately, the Tax Office won't let you deduct capital losses from your income. What you can do is to offset your capital losses against capital gains made in the same year, so that you pay less tax on the gains, and then 'carry forward' any remaining capital losses to be deducted against future capital gains.
Records
You must keep good records. Keep all receipts and any details of financial transactions, insurance and valuations, records of repairs and so on, and especially records of sale or disposal.
Incomplete records could lead to you paying more tax than is necessary. Make sure you record the nature of the asset and related transactions, how the asset resulted in a capital gain or loss, the dates involved and the persons or other businesses involved.
With over 30 years of experience as a tax professional in both the UK and Australia, Mark Chapman has established himself as a leading expert in taxation for individuals and small to medium-sized enterprises (SMEs). Currently serving as the Director of Tax Communications at H&R Block (NYSE:HRB) Australia, Mark has been with the company since 2015, where he plays a pivotal role in shaping and delivering tax advice across various media channels.