The Australian Taxation Office (ATO) requires the inclusion of capital gains and losses when lodging tax returns because these transactions form part of one’s assessable income.

Taxation on the profits from asset sales triggers a special kind of duty called capital gains tax (CGT). Before discussing CGT-triggers and its formula for computation, however, it is important to understand the basics first.

Definitions

Some terms related to capital gains, losses and taxes are:

Capital assets: All assets acquired beginning September 20, 1985, whether for business or personal use, no matter how small or large, as long as it is usable for more than a year. These can be real property, machineries and equipment, collectables (i.e., paintings and signed books), stocks, bonds, options, rights or other investment securities.

Ownership of capital assets may also be acquired through purchase or inheritance. It is important for the owner to record when exactly ownership was transferred because this date is crucial for determining eligibility for discounts and exemptions.

Cost base: The price of the asset when it was originally purchased, plus all the expenses related to the purchase such as legal fees, stamp duty, depreciation, etc.

Personal use asset: Items which were purchased solely for recreation or personal enjoyment of the owner and/or their associates, such as furniture, electrical equipment and boats. Only personal assets amounting to $10,000 and above are subject to CGT.

Collectables: Items like stamp collections, antiques, rare manuscripts, paintings and the like which are purchased mainly for the personal enjoyment of the owner and/or their associates. Options, rights and debts are included as long as the collectable was acquired for above $500 and bought on or before December 16, 1995.

Capital gain: Capital gain is the profit that asset owners receive from the sale of their capital assets. Computing for the capital gain is straightforward because one only needs to subtract the cost base from the sale price.

Capital loss: The opposite of capital gain, capital loss happens when the selling price of an asset is below the cost base due to depreciation, among other things. Capital losses may be applied to future CGT and income tax to decrease the cost base.

Capital gains tax (CGT): Once the sale transaction is finalised, the asset owner must report their gains or losses as part of their assessable income (if the asset is not exempted from CGT).

More on capital gains

Capital gains may be considered short-term or long-term depending on the length of time the owner held onto the asset from the initial purchase to the eventual sale.

Let’s assume the sale transaction resulted in a capital gain.

Holding period and taxation
If the ownership was held for less than 12 months from the date of purchase, this will be considered a short-term capital gain and will be taxed based on the owner’s marginal tax rate. However, if the owner held onto the asset for at least 12 months before selling it, this will be considered a long-term capital gain and the owner may be eligible for a 50 per cent CGT discount.

Realised and unrealised gains
These refer to the asset’s appreciated value but does not necessarily trigger CGT.

This is because having unrealised capital gains means that the owner simply noted that the asset appreciated in value. They did not sell the asset so the gains were not realised and they are not taxed. When they do sell the asset, the perceived capital gain will be realised and will automatically trigger CGT—unless it falls under one of the ATO exemptions.

CGT exemptions

There are several circumstances that exempt owners from paying CGT for the sale of their capital assets.

Some of these are:

• Assets acquired on or before September 19, 1985
• The real property is a family’s main residence
• Motor vehicles that can carry fewer than 9 passengers and can carry a load less than 1 tonne
• Motorcycle or a similar vehicle
• Depreciating assets for taxable purposes, like equipment for business use
• Personal use items purchased for less than $10,000
• Collectables purchased for $500 or less. These include collectables that were worth less than $500 when acquired, even if their price appreciated later on
• Awarded items such as medals—unless it was purchased
• Competition prizes and gambling winnings or losses

How to compute for capital gain or loss

In order to compute for capital gain or loss, the asset owner must know the asset’s purchase price and the expenses related to the initial purchase. All these will form part of the cost base.

To compute for the cost base, subtract any depreciation and first home owner grant from the sum of the original purchase price and all related expenses.

In formula:

The next step is to factor in the asset’s final sale price or:

If the sale price is higher, the formula would result in a positive amount, which means there was profit from the sale. A negative amount means capital loss.

For example, a person buys $500 worth of shares 5 years earlier and the company becomes successful enough that its shares’ value increase five-fold to $2,500. When the shareholder sells all the shares they have, it would register a $2,000 capital gain for the owner because $2,500 - $500 = $2,000.

If the owner held the asset for more than 12 months, they could be eligible for the discount to lower their assessable income from the sale to $1,000.

Using the same example above, assume that the company’s stocks plummeted 10-fold and the shareholder sold at a loss for $50. This would register a capital loss of $450 since $50 - $500 = - $450.

The $450 loss may be used to offset any capital gains from the current or future tax returns.

This information has been sourced from the Australian Taxation Office.