Managing capital gains to reduce tax and boost your super

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Capital gains and your super
What are capital gains and CGT?
Strategies for managing capital gains and losses in super
CGT strategies for SMSFs
What super contributions can you use to offset CGT?

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.

Important

If you are considering using any super strategy to reduce your tax bill, you should always speak to a registered tax agent or accountant before taking any action.

CGT is a very complex area of taxation law and a qualified tax professional will be able to help you successfully navigate the rules and may also be able to determine if you can use any other tax minimisation strategies.

This information is of a general nature only and cannot be considered financial advice.

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.

Case study 1

Jeff has an SMSF in accumulation phase and has made capital gains of $10,000 on the sale of SMSF shares this year. The shares were held by his fund for longer than 12 months, so his SMSF is eligible for the CGT discount. The fund also has an unapplied capital loss of $3,000 from earlier years that can be offset against this year’s capital gain.

The net capital gain for Jeff’s SMSF is calculated as follows:

Net capital gain = $10,000 – $3,000 = $7,000

Taxable CGT amount = $7,000 – ($7,000 x 1/3 discount)

= $7,000 – $2,333.33

= $4,666.67

This net capital gain amount will be added to the SMSF’s income and taxed at 15% or a tax liability of $700 ($4,666.67 x 0.15 = $700).

Note: To be eligible for the concessional tax rate of 15% on all income earned, an SMSF must be a complying fund adhering to all the legal requirements for an SMSF. If it’s non-complying, tax is levied at 45%.

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.

Case study 2

Rajiv is expecting to retire next year. His SMSF has a balance of $900,000 and is wholly in accumulation phase. Within that balance is a parcel of shares bought for $10,000 15 years ago and now worth $30,000.

If Rajiv sold the parcel of shares today, and he had no other capital gains or losses, he would have a tax liability of $2,000:

$30,000 – $10,000 = $20,000 capital gain

$20,000 – ($20,000 x 1/3 discount) = $13,333.33

$13,333.33 x 0.15 = $2,000

But if Rajiv held the asset for one more year and sold the parcel of shares once his fund was wholly in retirement phase, the tax liability would become zero and he would be $2,000 better off.

Rajiv needs to consider other factors, however, such as the investment outlook for the asset. If the investment was to fall in value by 50% before he retired, for example, his current tax liability of $2,000 would pale in comparison to the loss of $15,000 to the SMSF.

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.

Case study 3

Bill and Bo have an SMSF and are both two years away from retiring. They have an investment in a bundle of XYZ shares which they bought for $10,000 two years ago, but the value has now fallen to $9,000. They want to sell that bundle of shares before they fall in value further but, if they do, the fund will experience a capital loss of $1,000.

They also have an investment in ABC shares, which they bought three years ago for $10,000 and currently worth $11,000 but have stayed at that value for the past 12 months. They have been discussing whether or not to wait until they both retire to sell both parcels of shares so as not to realise any capital gains.

They finally decide to sell both parcels of shares this year with the capital gain completely offset by the capital loss. They then use the proceeds to buy $20,000 worth of TUV shares, which has excellent growth prospects. That bundle of shares increases in value over the next four years to $25,000. When they sell them in retirement phase for a net capital gain of $5,000, it incurs no tax. This is potentially a better outcome than if they held onto their previous two parcels of shares and sold them in retirement phase.

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.

Case study 4

Ayumi and Takashi are both working and decide to sell the portfolio of shares they have held outside super for many years. This sale results in a capital gain of $150,000, on which they will be required to pay CGT. The couple uses the normal 50% discount rule for CGT applying to assets held for over 12 months, reducing their capital gain to $75,000.

Both Ayumi and Takashi’s employers have made concessional (before-tax) contributions into their super accounts of $7,500 during the year. This means they both still have $20,000 left under their annual concessional contributions cap of $27,500.

After receiving tax advice from their registered tax agent, they both decide to make a concessional super contribution of $20,000 each into their super accounts from their profit on selling the shares. Ayumi and Takashi both claim their $20,000 contribution as a personal tax deduction.

This reduces the capital gain on which they must pay tax from $75,000 to only $35,000 ($75,000 – [$20,000 x 2] = $35,000).

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.

Learn more about concessional super contributions.

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.

Learn more about your Total Super Balance and carry-forward (catch-up) super contributions.

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.