An investment property purchased for $1.2 million is sold after 3 years for $1.5 million. The owner incurred $50,000 in capital improvements and $25,000 in selling costs. What is the assessable capital gain for a taxpayer in the highest tax bracket?
Correct Answer
A) $112,500
Capital gain is $1.5M - $1.2M - $50K - $25K = $225,000. After holding for over 12 months, the 50% CGT discount applies, making the assessable capital gain $225,000 ÷ 2 = $112,500. Capital improvements and selling costs are deductible from the gain.
Why This Is the Correct Answer
Option A correctly applies the CGT calculation formula. The capital gain is $1.5M - $1.2M - $50K - $25K = $225,000. Since the property was held for over 12 months (3 years), the 50% CGT discount applies under Division 115 of the Income Tax Assessment Act 1997. This reduces the assessable capital gain to $225,000 ÷ 2 = $112,500. The calculation properly deducts both capital improvements and selling costs from the gross gain before applying the discount.
Why the Other Options Are Wrong
Option B: $225,000
This represents the gross capital gain before applying the 50% CGT discount. While the calculation of $225,000 is correct ($1.5M - $1.2M - $50K - $25K), it fails to apply the mandatory 50% discount available for assets held longer than 12 months. The assessable amount for tax purposes is half this figure.
Option C: $150,000
This figure appears to be the difference between sale and purchase price ($300,000) minus only the selling costs ($25,000), incorrectly excluding the $50,000 capital improvements from the cost base. It also fails to apply the 50% CGT discount that reduces the assessable gain for assets held over 12 months.
Option D: $300,000
This represents only the gross difference between the sale price and purchase price ($1.5M - $1.2M = $300,000), completely ignoring both the deductible costs (capital improvements and selling costs) and the 50% CGT discount. This would significantly overstate the assessable capital gain and the resulting tax liability.
Deep Analysis of This Finance Taxation Question
This question tests understanding of capital gains tax (CGT) calculations for investment properties under Australian tax law. The calculation involves determining the capital gain by subtracting the cost base (purchase price plus capital improvements) and selling costs from the sale price. The key principle is the 50% CGT discount available to Australian tax residents for assets held longer than 12 months. This discount significantly reduces the assessable capital gain, making property investment more attractive. The question demonstrates how capital improvements and selling costs reduce the taxable gain, encouraging property maintenance and acknowledging transaction costs. Understanding CGT calculations is crucial for real estate professionals advising clients on investment strategies, as the tax implications can significantly impact investment returns and decision-making around timing of sales.
Background Knowledge for Finance Taxation
Capital Gains Tax in Australia applies to investment properties under the Income Tax Assessment Act 1997. The capital gain equals sale price minus cost base (purchase price plus capital improvements) minus selling costs. For assets held over 12 months, individuals receive a 50% CGT discount on the net capital gain. Capital improvements that increase property value are added to the cost base, while selling costs (agent fees, legal costs, advertising) are deductible. The CGT discount encourages long-term investment and applies to Australian tax residents. Understanding these calculations is essential for property investment advice and compliance.
Memory Technique
Remember DISC: Determine the gain (Sale - Purchase - Improvements - Selling costs), then apply the 50% Discount for assets held over 12 months. Think of a 'DISC' being cut in half - just like your capital gain gets cut in half with the discount.
When you see a CGT question, immediately think DISC. Calculate the gross gain first, then check if it's held over 12 months. If yes, cut the gain in half like cutting a disc. This ensures you don't forget the crucial 50% discount step.
Exam Tip for Finance Taxation
Always check the holding period first - if over 12 months, you'll need to halve the final gain. Calculate: Sale price minus all costs, then apply 50% discount. Don't forget to deduct both capital improvements and selling costs before applying the discount.
Real World Application in Finance Taxation
A property investor purchases a rental property for $800,000, spends $30,000 on renovations, and sells it 18 months later for $950,000 with $20,000 in selling costs. The capital gain is $950,000 - $800,000 - $30,000 - $20,000 = $100,000. With the 50% CGT discount, the assessable gain is $50,000. This knowledge helps real estate agents advise clients on timing sales and understanding tax implications of property improvements.
Common Mistakes to Avoid on Finance Taxation Questions
- •Forgetting to apply the 50% CGT discount for assets held over 12 months
- •Not deducting capital improvements from the capital gain
- •Excluding selling costs from the calculation
Related Topics & Key Terms
Key Terms:
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