Not being paranoid or anything but we were curious about the skills of the latest innovation to take the world by storm, ChatGPT, and its ability to work with the Australian tax system.

Question: How much capital gains tax does an Australian resident pay on an investment property with a worked example.

ChatGPT: An Australian resident pays capital gains tax (CGT) on the profit made from selling an investment property. The CGT is calculated by subtracting the cost of the property (purchase price plus any costs associated with acquiring and owning the property) from the sale price.

For example, let’s say an Australian resident purchased an investment property for $500,000 and spent $50,000 on costs associated with acquiring and owning the property (such as legal fees, stamp duty, and repairs). The total cost of the property is $550,000.

The accountant: Let’s stop there and take stock. There are some tricks and traps that need to be considered when working out an asset’s cost base.

While repair costs in some cases can form part of a property’s cost base, this is not always the case. The situation is often different where the asset being sold is an investment property that has been rented to tenants. When a landlord repairs damage that occurs while the property is rented to a tenant, this will often be deductible to the landlord at the time the repair costs are incurred. Because deductions are available for these repair costs, they should not also be included in the property’s cost base.

There are also other adjustments that need to be considered. In the context of investment properties, it will often be necessary to make adjustments to the cost base to take into account capital works deductions. Landlords can often claim capital works deductions when an investment property is used to derive assessable rental income. The property’s cost base should then be reduced by capital works deductions that have been or could be claimed by the landlord (although there is an exception to this if the property was acquired before 13 May 1997 and the cost of improvements was incurred by 30 June 1999).

The longer the period of ownership, the more likely that capital works deductions and repair costs can end up being quite significant and have a material impact on the capital gain calculation.

ChatGPT: After several years, the resident decides to sell the property for $700,000. The profit made from the sale is $700,000 – $550,000 = $150,000.  The CGT rate in Australia is currently at 45% and the resident will pay 45% of the $150,000 profit, which is $67,500.

The accountant: Let’s take a closer look at that calculation. There is no CGT rate of 45% that applies specifically to capital gains. Net capital gains form part of an individual taxpayer’s assessable income. This figure is then used to calculate the individual’s taxable income for the relevant income year. If there is a positive taxable income figure, then we apply the individual’s marginal tax rates.

One way of explaining this is that a higher taxable income normally results in a higher tax bracket and a higher rate of tax. In other words, the tax rate that applies to an individual’s net capital gains is impacted by the individual’s other income or losses (if any).

Also, while the highest marginal tax rate for individuals is currently 45 per cents for each dollar of taxable income above $180,000, Australian residents are also normally subject to the Medicare levy of 2%.  This should be considered and factored in.

ChatGPT: It’s worth noting that there are certain exemptions and reductions that can be applied to the CGT calculation, such as the main residence exemption and the small business CGT concessions.

The accountant: If only tax was that simple! There are certain exemptions and reductions that can apply to capital gains. While the answer mentions the main residence exemption and the small business CGT concessions, these concessions do not normally apply to the sale of an investment property.

For the main residence exemption (or partial main residence exemption) to be available, one of the key conditions is that property would need to have been established and used as the individual’s main residence.  The exemption is unlikely to be available if the property has been used solely as an investment property to derive assessable rental income, although if the property was inherited then the position could be different.

Also, the small business CGT concessions would not normally apply to the sale of an investment property.  This is because the concessions can only apply if the asset passes an active asset test, which requires the property to have been used in qualifying business activities for a minimum period of time.

Assets used in a business carried on by the owner or certain related parties can often be treated as active assets for the purpose of these concessions, but there is a specific exception for assets used mainly to derive rent from unrelated parties.

If the property has been solely used to derive rent (even if used in a rental business) from unrelated parties, the property is likely to fail the active asset test and the small business CGT concessions shouldn’t be available.

Interestingly, the answer didn’t refer to the general CGT discount or indexation, which are the most likely concessions that would apply to a situation like this.

If the seller is an Australian resident (and not a temporary resident) during the period they owned the property and has owned the property for more than 12 months, the 50% CGT general discount would often be available to reduce the capital gain. 

If the property was acquired before 21 September 1999, indexation of the cost base could be available instead. It would be necessary to compare both options to see which provides the more favourable result.

ChatGPT: It is advisable to consult with a tax professional to determine the specific tax implications of selling an investment property.

The accountant: Yes, indeed it is. Thank you ChatGPT.

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