Updated: Jun 17
✦ The investor has two great benefits from the tax legislation in Australia
The first is Section 8.1 of the Income Tax Assessment Act 1997 which states: “You can deduct from your assessable income any loss or outgoing to the extent it is incurred in gaining or producing your assessable income.”
The second is the capital gains discount introduced by John Howard in 1999.
Section 8.1 Income Tax Assessment Act 1997
At first glance Section 8.1 looks as if it can cover almost anything.
But further on the section says:
You can’t deduct losses or outgoings of capital or of a capital nature (eg: the amount of the principal repayment on a mortgage payment);
You can’t deduct losses or outgoings of a private or domestic nature (eg: clothing, most travel to and from work);
If a part of the taxation legislation prevents you from claiming it (eg: travel to residential investment properties to inspect or carry out repairs).
So, if you borrow money to buy an investment property which you are going to receive rent from or to buy shares that pay dividends the interest expense will normally be tax deductible. The important question is what was the money borrowed for, not what is the bank or credit union using for security.
One fee that people might not be aware that can be claimed is the expenses of ongoing financial advice which leads to, or is directly associated with, a specific investment which produces assessable income. So the initial cost of getting a financial plan drawn up is regarded as a capital expense because it is before you earn financial income. Generally the ongoing fees would be tax deductible.
Capital Gains Discount
From 1985 to 1999, Australians paid capital gains tax based on the actual gains after inflation. So if you bought something for $100,000 and the consumer price index increased 20% resulting in an indexed cost base of $120,000 ($100,000 plus 20% of $100,000), you paid capital gains tax on any excess you received above $120,000. If you received $150,000 the capital gains tax was calculated on $30,000. You claimed a loss if you sold for less tan $100,000 based on the cost price of $100,000. If you sold between $100,000 and $120,000 then you weren’t subject to capital gains tax.
In December 1999, John Howard introduced a law that meant indexation did not need to be considered, but that if you hold an asset for more than 12 months any capital gain can be discounted by 50%, so in effect 50% of the gain is tax free.
So if my cost base is $100,000 and I hold the asset for 5 years and sell for $200,000 I have made a gain of $100,000. As the asset has been held for more than 12 months 50% ($50,000) of the gain is disregarded and I pay tax on the remaining $50,000.
Traps for the unwary
The investment isn’t earning income. If I borrow money to buy shares in a company that doesn’t pay dividends (eg: an early stage mining company, Tesla, or Berkshire Hathaway) then I am not receiving assessable income from the investment and I cannot claim a deduction for the interest on the borrowed money.
Similarly many digital currencies do not produce income so if you borrow to invest in them the interest on the borrowings is not a deduction.
Capital losses can only be applied against capital gains. Capital losses cannot be deducted against income. So if I earn $100,000 and have a capital gain of $50,000 I pay tax on $150,000. If I lose $50,000 on an investment that does not get deducted from my income so If I earn $100,000 I will pay tax on $100,000 and the $50,000 gets carried forward into subsequent financial years until there are capital gains it can be applied against. So in the tax year you are making capital gains you should also consider if there are any investments you have made a loss on. If so, you might want to sell them in the same financial year so you can claim the capital losses against the capital gains.
At least ‘12 months’ excludes the date the asset was acquired and the date it was disposed of, so if you buy something on 31 December and dispose of it the following 31 December you have not owned the asset for at least 12 months.
As always, this article provides general taxation advice only, and you should consult a tax agent or accountant for advice that is specific to your circumstances.
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