A capital gain or loss is the difference between what it cost you to purchase an asset, and what you receive when you sell or dispose of it. Without taking into account legislated discounts, if the amount you sold the asset for is higher than what you purchased it for, you have made a capital gain. Capital Gains Tax (CGT) needs to be paid on capital gains. If you sell an asset for lower than the original purchase price, you have made a capital loss. If you make a capital loss, it can be used to reduce capital gains made in the same income year. CGT is not a separate tax, but forms part of your assessable income.
Some assets are exempt from CGT. These include your main residence, and assets that you acquired before 20 September 1985 (with some exceptions relating to private company shares and interests in private trusts). Click here to visit the ATO website and view the whole list.
It would be easy to assume that a pre-1985 family home would be free from CGT, but this approach is incorrect. Recently the Australian Tax Office has made a determination finding that CGT can be payable on intangible capital improvements made to a pre-1985 CGT asset, which can be considered separate to the asset itself.
CGT payable on intangible capital improvements
In January 2017, the ATO released TD 2017/1, a taxation determination considering whether intangible capital improvements made to a pre-CGT asset are considered to be separate assets for the purpose of subsections 108-70(2) and (3) of the Income Tax Assessment Act 1997. These subsections provide that a capital improvement to a CGT asset is taken to be a separate CGT asset if:
its cost base (assuming it were a separate CGT asset) when the CGT event occurs in relation to the original asset is more than the improvement threshold for the income year in which the event happened; and
is more than 5% of the capital proceeds from the event.
The ‘cost base’ is the cost of the asset when you initially purchase it. The ‘improvement threshold’ for each income year is indexed annually. For the 2016-2017 income year, the improvement threshold is $145,401.00.
Tangible or intangible capital improvement?
Previously it was unclear whether these subsections applied to intangible improvements, or just tangible improvements. An example of a tangible improvement is provided in the legislation:
In 1983 you bought a boat. In 1999 you install a new mast (a capital improvement)…
In this example, the mast is a tangible capital asset. Depending on the cost base and improvement threshold, the mast could be considered as a separate asset.
In TD 2017/1, the ATO have included an example of an intangible capital improvement:
A farmer, holding pre-CGT land, obtains council approval to rezone and subdivide the land. Those improvements may be separate CGT assets from the land.
Again, if the cost base, improvement threshold and proceeds meet the criteria in subsections 108-70(2) and (3), the intangible capital improvement will be treated as a separate asset.
Intangible capital improvements can be considered as separate CGT assets from a pre-1985 CGT asset to which improvements are made. The asset will be considered separately if the tests outlined in subsections 108-70(2) and (3) of the Income Tax Assessment Act 1997 are satisfied.