Capital gains tax, also referred to as CGT, is a financial terminology most Australians have likely heard of but might be less likely to know how to calculate. Like a few accounting concepts, it can be confusing for a first-timer to wrap their head around. However, if you plan on purchasing or selling any notable assets, like property or cars, understanding the ins and outs of CGT now can pay off later. In fact, if you plan on selling an asset you will undoubtedly experience what CGT is hands-on. To help familiarise yourself with CGT, Shoebox Books have put together the layman’s guide to how you can understand calculating your CGT when it comes time to sell.
What is Capital Gains Tax?
Before we dive into how you can start calculating your CGT, you ought to understand what exactly constitutes capital gains tax. Capital gains are the difference between how much you pay for an asset, say a car, compared with how much you received when you sell the car (discounting the cost involved in selling it). In 1985, capital gains tax was introduced to Australia. Essentially, this is the levy you pay on the capital gain in the year you sold the car.
Whilst we used a car as an example, CGT can apply to several types of assets, including real estate, shares, contractual rights, licenses, business investments and even personal assets, as long as they’re above a specific value. There are some exemptions in certain situations, but we’ll get onto those a little later.
What Happens When You’ve Made a Capital Gain?
Imagine you have just sold your car, and you’ve made a capital gain. These proceeds then are added to your total assessable income. This means the gain could increase the tax you need to pay when you submit your tax return. On the other hand, if you experience a capital loss, you can use it to reduce a capital gain in the same financial year. If your losses are greater than your gains, or if your loss is in a financial year where you didn’t make a capital gain, you can instead deduct this from future capital gains.
How to Calculate Capital Gains Tax
In calculating your capital gains tax, you’ll quickly learn there are a couple of methods that exist. To make it easier to decide which method you should go with, we’ve broken down what each method entails, beginning with the indexation method. But keep an eye out for our discount method, which will be coming soon to the blog.
What is the Indexation Method?
The indexation method is one process used to calculate CGT, most prominently on assets that are acquired and held for a notable period of time. The indexation method can be used on assets that are acquired before 11:45 am (ACT time) on 21 September 1999. These must have been for 12 or more months.
It may be confusing to know which method to choose but be rest assured there is no one reason for you to select one option over the other. It relies more on the type of asset you own, how long you’ve owned said asset, as well as the past inflation rates.
In Australia, CGT is calculated by treating the net capital gain as taxable income in the year you sell your asset. If you have owned that asset for more than 12 months, the gain is discounted by 50% for individuals and business owners, and 33.3% for superannuation funds. Where you are located in the world determines how you will calculate your capital gains tax. So it is important to learn the method that is standard in your country.
How to Calculate CGT Using the Indexation Method
You’ve likely had a conversation with a parent, grandparent or colleague about the cost of a car, property or asset they purchased decades ago. CGT indexation utilises a method similar to this.
The indexation method, in particular, increases the purchase costs by using an indexation to factor in the inflation between the date you purchased your asset, and the date you sold it.
Capital Gains Tax Indexation Formula
Remember, you can use the indexation method to calculate your CGT if:
1. The CGT asset was attained before 11:45 am on 21 September 1999.
2. You owned the asset for longer than 12 or more months.
To make CGT as simple as possible, we’ll use the property as an example, as well as a formula you can substitute with your own figures.
For example, the capital gains tax index is calculated by dividing the consumer price index (CPI) at the time you sold your property, by the CPI at the time you bought the property (rounded to three decimal places).
As a formula, this will look like this:
A= B ÷ C
A= is the indexation factor.
B= is CPI for the time period (quarter) when the CGT event occurred.
C= is CPI for the time period (quarter) in which expenditure was incurred
It’s important to note, the ATO provides a consumer price index (CPI) each quarter, which you can use to calculate your capital gain.
Capital Gains Tax Exemptions for Small Businesses
If you are a small business owner, you’ll want to keep reading here, as there are a few capital gains tax exemptions and concessions that will affect you. Offered by the ATO, your business must fit the criteria to qualify.
The common conditions to be granted the concessions are:
1. Your small business turnover is less than $2 million dollars.
2. The asset you are assessing satisfies the active asset test.
3. If the asset is a share in a company or an interest in a trust, the additional conditions are met.
4. The interest is a membership interest of the entity in the partnership.
So there you have it, CGT calculated using the indexation method. Remember, there is no right or wrong method of calculating your CGT. It all depends on your situation, assets and which method is the most capable of reducing your tax liability. While paying taxes on your assets isn’t always avoidable, learning the different types of CGT will assist you in future asset purchases and how you can be more tax-efficient.
No matter if you are a small business owner, or an individual who would like assistance with their financial handling, the team at Shoebox Books can assist you. As bookkeeping professionals based in Australia, we are well-versed and specialised in Australian taxation regulations. To learn more about our services and how we can help you with your CGT, contact our friendly and professional team today. With the assistance of our team, taxes no longer have to be complex.