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When you invest – either through an SMSF, the investment option in your super account or outside super – you make capital gains when asset values increase and capital losses when their values fall.
While the object of investing is to build your capital, the downside of making significant capital gains is that you can end up with a tax liability when the assets are sold, or at the end of the financial year.
But all is not lost. In some circumstances, you can reduce your potential capital gains tax (CGT) bill using a few simple strategies both inside and outside super.
Capital gains and your super
When it comes to your super, there are two main strategies where capital gains and losses can be used to improve your overall tax position:
- Matching various capital gains and losses within the investment portfolio of your SMSF to improve your overall tax position.
- Offsetting capital gains you make on assets held outside the super system with tax deductions received for making contributions into your super account.
Both strategies can reduce your overall tax bill and will be explained in more detail later in this article. In the meantime, it’s important to understand that these two approaches work in different ways and are not open to all super fund members.
The first strategy is available if you’re a trustee of your own SMSF and are aiming to manage the tax payable on your investment returns in a particular financial year.
It may also be available to super fund members who make direct investments through their super account using a Member Direct investment option, provided the option rules permit members to carry forward capital losses.
If you’re a member of a large industry or retail super fund and your investment option is a pre-mixed option (such as High Growth, Balanced or Conservative), you’re unlikely to be permitted to match capital gains and losses within your super account. Members investing in these investment options usually don’t have to worry about CGT, as the crediting rate or unit price for their investment option is usually declared after all the relevant administration (including paying tax to the ATO) is completed by the fund.
The second strategy for managing CGT is more widely available. You can use this one with capital gains made on assets held outside the super system.
It involves reducing your CGT liability when you sell an asset outside the super system by offsetting it with a tax deduction you receive for making a tax-deductible personal super contribution. This is a win-win as it not only reduces the tax you pay but it also increases the amount you have in your super account.
What are capital gains and CGT?
Before rushing into the strategies, it’s worth quickly brushing up on the basics of how CGT works. CGT is part of your normal income tax and isn’t a separate tax. Under tax law, whenever you sell an asset and make a capital gain, you’re usually required to pay some tax on the capital gain you’ve made since purchasing the asset.
For example, if super fund A bought asset X three years ago for $100,000 but sells it for $120,000, the capital gain made on that asset is $20,000. Conversely, if the fund sells asset X for $80,000, it suffers a capital loss of $20,000.
When your capital gain is calculated, you’re permitted to offset it against any capital losses to determine your net tax position, on which the amount of CGT is calculated. Generally there is no time limit on how long a capital loss can be held to offset future capital gains.
The ATO defines a net capital gain as:
- total capital gain for the year
less
- total capital losses for that year and any unapplied capital losses from earlier years
less
- CGT discount and any other concessions.
Strategies for managing capital gains and losses in super
Strategy 1 – Matching capital gains and losses within your super or SMSF portfolio
This strategy for reducing your capital gain is available if you’re the trustee of your own SMSF. (In large super funds, it may be available to fund members choosing a Member Direct investment option if its rules permit them to carry forward a realised capital loss.)
During the process of buying and selling assets during a financial year, SMSFs usually generate both capital gains and capital losses. The CGT liability for any capital gain depends on whether the fund is in accumulation or retirement phase and whether there are fund members in each of those phases:
a. Retirement phase CGT rules
As income earned in retirement phase is tax free, if the asset is sold in retirement phase, the SMSF will have no CGT liability on the capital gain.
b. Accumulation phase CGT rules
If an SMSF is wholly in accumulation phase, it will pay CGT on the fund’s annual net capital gain. The net gain is treated as income for tax purposes, so it will be taxed at the same rate (15%) as other income in the fund. If an asset is held for more than 12 months, any capital gain is eligible for a discount of one-third, resulting in an effective tax rate of 10%.
Capital losses in SMSFs in accumulation phase can only be used to offset capital gains and cannot be used to offset any other income. A capital loss can be carried forward to future years in accumulation phase and used to offset capital gains at that time.
CGT strategies for SMSFs
SMSFs can use the CGT rules in several ways to reduce their tax bill:
a. Deferring capital gains – This involves simply deferring the sale of an asset on which you expect to make a capital gain until all the members of the SMSF are in retirement phase.
b. Using a capital gain to offset a capital loss
Capital losses from SMSF asset sales can be held until the fund experiences a capital gain. If the fund is expecting a capital loss in a particular year (such as from selling a poorly performing asset), it’s sensible to realise a capital gain in the same financial year. This is very useful when all the fund members are getting close to retiring, as carrying forward capital losses is worthless when the SMSF moves wholly from accumulation to wholly retirement phase and becomes tax free.
Strategy 2 – Offsetting capital gains outside super with tax-deductible super contributions
As CGT is calculated using the same rules as income tax, you can use tax deductions to offset your tax liability. If you meet the eligibility conditions, you can claim a personal tax deduction for certain types of super contributions and offset this deduction against some (or all) of your taxable gain.
Before using this strategy, it’s important to remember that all concessional contributions are taxed at 15% (or 30% if your income is greater than $250,000) when it’s received by your super fund.
What super contributions can you use to offset CGT?
The short answer is any personal concessional contributions on which you claim a tax deduction.
If you plan to use a super contribution to offset a capital gain, in most situations you are limited to claiming a $27,500 tax deduction each financial year, which is the annual general concessional contributions cap. Your personal concessional cap may be different depending on the amount of super guarantee (SG) and salary-sacrifice contributions made by your employer on your behalf.
The exception to the cap are carry-forward contributions. From 1 July 2018, anyone with a Total Superannuation Balance under $500,000 can access their unused concessional contributions caps to make carry-forward contributions. If you haven’t used all your concessional caps over several years, the unused cap amount could make a significant dent in a large CGT liability.
If you make a personal contribution and plan to claim a tax deduction, you need to submit a valid Notice of Intent to Claim or Vary a Deduction for Personal Super Contributions form from the ATO. Before lodging your tax return, you need to receive an acknowledgement of receipt from your super fund.
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