If you’re wondering, ‘What is capital loss?’ consider the unpredictable nature of investments. Assets like property and shares can offer lucrative returns, but sometimes, things don’t pan out. Selling an asset such as a property, for less than the purchase price, a loss is not uncommon. In such cases, you experience a capital loss instead of a gain.
When this happens, you make a capital loss instead of a capital gain.
So, what does that mean for your tax obligations?
Here’s what you need to know.
What is Capital Gains Tax?
Let’s start with a definition of what a capital gain is for tax purposes.
Capital gains tax (CGT) refers to the tax paid on the profit made from the sale of an asset, such as real estate or shares. The capital gain is the difference between what it cost you to acquire the asset and what you received when you disposed of it. You don’t pay capital gains tax as a separate tax, but, instead, it forms part of your income tax.
Key Points about CGT in Australia:
- Calculation: The capital gain is typically calculated as the difference between the sale price of the asset and its original purchase price, along with associated costs like legal fees, stamp duty, and improvements made to the asset.
- Discount Method: If you’ve held the asset for more than 12 months, you may be eligible for a 50% discount on the capital gain, effectively reducing the taxable amount by half.
- Main Residence Exemption: If the asset sold is your primary residence, you might be exempt from CGT. However, there are specific conditions to meet for this exemption.
- Non-Residents: Foreign residents are subject to CGT on Australian assets, with some differences in rules, especially concerning concessions.
- Reporting: Any capital gain or loss should be reported in your annual income tax return. It’s essential to keep detailed records of every asset transaction to calculate and report CGT accurately.
- Assets Acquired Before 1985: Assets acquired before September 20, 1985, are generally exempt from CGT.
Understanding Capital Losses
When you sell an asset, such as a property, and the sale price is lower than the purchase price, you incur a capital loss. In other words, a capital loss refers to the losses you make when selling an asset.
Upon selling an asset, you will either make a capital gain or a capital loss. If you make a profit, you will have to pay tax on the capital gain. However, if you incur a loss, you have the opportunity to carry that loss over to future tax years.
Carrying Over a Capital Loss
If you incur a capital loss, you can’t directly deduct it from your other forms of income, such as salary or rental income. Instead, its primary use is to offset capital gains.
How Can You Use a Capital Loss to Offset a Capital Gain?
In Australia, if you incur a capital loss, you can’t directly deduct it from your other forms of income, such as salary or rental income. Instead, its primary use is to reduce capital gains.
Offsetting in the Same Year
If you’ve made both capital gains and capital losses in the same year, you can use the losses to reduce your total taxable capital gains. For example, if you made a capital gain of $20,000 on the sale of shares and a capital loss of $5,000 on the sale of a different set of shares, you could offset the loss against the gain, resulting in a net capital gain of $15,000.
Carrying Forward to Future Years
If you don’t have any capital gains in the year you incurred the capital loss or if your losses exceed your gains, you can ‘carry forward’ the unused losses to offset against net capital gains in future years. There’s no time limit on how long you can carry forward a capital loss, but it’s crucial to maintain accurate records to ensure you apply it correctly in future tax returns.
Let’s consider an example to illustrate how carrying forward the loss works.
Let’s say you invest in shares in the current year, purchasing them for $5,000. Unfortunately, you sell these shares at a later date for $4,000, resulting in a capital loss of $1,000. You didn’t make any capital gains this year, so you’ll be able to use this loss when you do eventually sell an asset and make a gain.
Now, let’s say you have a capital gains tax event the following year and you sell a property for $685,000 that you purchased for $355,000. You can offset the taxable amount of your capital gain ($330,000) with the capital loss of $1,000 you previously incurred from the shares. Your capital gain reduces to $329,000
You qualify for the 50% capital gains tax concession, so you only have to pay tax on half that gain, which is $164,500.
So, you’ll only be adding $164,500 to your income for the year instead of $335,000.
Capital Losses on Your Main Residence
If you make a net capital loss on your main residence and you were a resident of Australia at the time of selling, the capital loss on this property can be disregarded. This exemption applies because the sale of your main residence is generally exempt from capital gains tax. Therefore, any capital loss incurred from the sale of your main residence does not have any tax implications, unless it has been used for income-earning purposes at any point.
Key Takeaways
While the prospect of a capital loss may seem daunting, it offers opportunities to offset future capital gains, potentially reducing tax obligations. With the right information and proactiveness, you can strategically manage your assets to optimise financial outcomes.
For those unsure about the intricacies of capital gains tax and capital losses, seeking guidance from experts like Property Tax Specialists can be invaluable in ensuring both compliance and the maximisation of benefits.
Frequently Asked Questions
Can I Deduct Capital Losses from My Income Instead of Carrying Them Over?
No, it is not possible to deduct capital losses from your income. The Australian taxation system specifies that capital losses can only be carried over to the next financial year and used to offset future capital gains.
What Strategies Can I Use with Capital Losses to Avoid Capital Gains Tax?
One effective strategy to minimise capital gains tax is to plan your losses and time them strategically. Selling assets with a potential capital loss before selling assets with a potential capital gain could allow you to offset the gain with the loss, reducing your overall tax bill. But this is just general advice. You must consult an expert regarding your personal circ*mstances.
Is a Tax Loss the Same as a Capital Loss in Australia?
No, tax losses and capital losses are distinct concepts. Tax losses can arise from income, while capital losses occur when you dispose of an asset for less than its tax value.
Disclaimer
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.
