As we draw near the end of financial year, it’s nearly time to lodge your tax return, writes Mark Chapman, director of Tax Communications at H&R Block (NYSE:HRB), saying he gets many questions from investors at this of year concerned about the tax implications of their activities during the year.
Here’s H&R Block’s pick of those questions – and Chapman’s answers - which hopefully will make tax time easier for you too!
Your investments have gone down. Can you claim a tax loss?
If you’ve disposed of shares or any other form of investment and you know you’ve made a capital gain, it makes sense to take a look at your investment portfolio and consider disposing of any assets which you own which you know are sitting at a loss. The resulting capital losses can be offset against the capital gain to reduce your overall tax burden.
As we approach the end of financial year, this strategy is commonly used by investors looking to clear out their loss-making shares in a tax-effective way.
Be careful though if you sell shares sitting at a loss and then buy them back in the new tax year. The ATO takes a hard line against so-called ‘wash sales’.
This refers to the sale of an asset before the year end and the purchase of a substantially identical asset immediately after the year end. If this happens, the ATO can apply the anti-avoidance provisions to cancel any tax benefits and apply penalties.
If you do indeed have shares sitting a loss which you intend to sell in order to shelter other capital gains which have arisen during the year, make sure the sale is genuine and that there is no intention to buy back the stock in the new financial year.
How do you declare capital gains/losses on your return?
On the capital tax gains tax pages of the tax return. Dealing with the tax implications of shares and ETFs can be very complex.
Many investors use a tax agent, such as H&R Block, to ensure that their return is completed accurately. In particular, they will check that you are receiving all of your entitlements and that these flow through into your tax return, such as:
- franking credits on your Australian dividend income; and
- the 50% capital gains discount on investments held for 12 months.
It can make sense to take tax advice throughout all stages of your investment journey, from the initial investment right through to the sale of your portfolio.
Typically, CGT arises when you sell shares but can also happen if you give them away or you stop being an Australian resident. CGT taxes any increase in value from the time the share was acquired.
Your capital gain for a share is worked out like this:
- Deduct the cost base from the sale proceeds. The cost base is the price you paid for the share, plus incidental costs.
- Next, take away any capital losses.
- Then, discount the gain if you’re eligible. Individuals are entitled to a 50% discount. The asset must have been held for 12 months or more for the discount to be available.
- The resulting figure is your net capital gain. This is subject to tax at your marginal income tax rate.
TIP: Any shares acquired before September 20, 1985, are not subject to CGT.
Sometimes the proceeds and cost base of the share are not what was actually paid and/or received, but rather, the market value of the asset. This is typically to prevent people from minimising their tax by, say, selling the share to a relative for a low price.
Can you use investment losses to offset against your other income? And what about paper losses?
Investment losses that arise from the disposal of assets like shares, property and crypto are so-called capital losses. These can be offset against any other capital gains (profits from the disposal of assets) arising in the year or carried forward and offset against future year’s capital gains but they can’t be offset against other sources of income, such as wages, business profits, interest or dividends.
Paper losses are not generally available for use for capital gains tax (CGT) purposes. For example, I might have bought a share for $1 in the past and at the end of the financial year, it might only be worth 50 cents. I’m sitting on a notional loss of 50 cents but unless I actually dispose of the share at the year-end (crystallising that 50 cents loss), I can’t claim it as a capital loss.
It’s not really the same thing but many people regard certain cryptocurrency transactions as ‘paper’ gains or losses but actually the ATO regards them as very real.
Say I buy some Bitcoins and then exchange them for a different cryptocurrency. That gives rise to a capital gains tax event at the date of exchange, even though the taxpayer might argue the gain (or loss) is not actually realised into Australian dollars.
This is a common mistake that crypto investors make – you can easily find yourself with a CGT liability and no actual cash to pay it!
Do you need to pay tax on ETFs that automatically reinvest dividends?
ETFs often provide unitholders with an option to reinvest their distribution. Generally speaking, taxpayers will need to declare distributions despite not withdrawing any money from their account. Anything received through a dividend or distribution reinvestment plan is considered income and treated for tax purposes in the same way as receiving cash.
Generally, an ETF takes the form of a trust and the return paid by an ETF is treated like a distribution from the trust. However, that return will incorporate many different components, such as dividends, franking credits, interest, foreign income and capital gains.
Each of those individual elements then needs to be split out by you and entered into the correct boxes on your tax return. The potential for mistakes is considerable.
Fortunately, most ETF providers give investors a year-end tax statement, which breaks down the total distribution by the various elements and often contains instructions on which specific boxes to complete on your tax return.
Make sure you look out for (and keep) your annual tax statement because without it, completing your tax return accurately can be almost impossible.
What is the ATO watching in terms of investments this year?
Wash sales (see above) are firmly within the ATO’s sights this year.
In addition, if you dispose of an asset such as property, shares or a crypto asset, including non-fungible tokens (NFTs) this financial year, the ATO will be keeping a close eye on your tax return to make sure that the capital gain or loss is calculated correctly and, indeed, is recorded in the first place.
The ATO believes that many investors simply fail to record asset sales in their tax return and is receiving data from third parties (eg, state land registries, property management software providers, share registries and cryptocurrency service providers) which it can use to identify non-disclosure.