Super strategies for managing capital gains

Summary: Like it or not, when the value of assets increase, the prospect of having a Capital Gains Tax liability always creeps into the equation. But CGT can be reduced, or even eliminated.

Key take-out: Shifting assets with CGT liabilities from an accumulation fund to a pension fund will cut CGT liabilities to zero.

Having looked at the topic of capital gains recently in Tax-free loans from the ATO, and seen the advantage of deferring capital gains where possible, we now move to look at strategies to manage capital gains.

The Big Tax Break – Capital Gains Discount

The most obvious strategy, given the current tax rules, is to take advantage of the discount offered on capital gains where an asset is held for at least 12 months.  In a superannuation fund, this sees the tax rate decrease from 15 per cent to 10 per cent on a realised (meaning the asset is sold) capital gain.

Outside superannuation a 50 per cent discount is applied to the capital gain once the asset is held for 12 months.  These discounts significantly reduce the tax burden of a capital gains tax event.

Managed Funds and Capital Gains

Managed funds can be very difficult for investors to assess from a capital gains tax perspective – because very few publish after-tax returns.  Any trading that goes on in a managed fund, for example if a large investor sells their units in the fund and shares have to be sold, potentially sees capital gains passed on to unit holders as part of the fund distributions. 

It takes some investigation by an investor to find out what different parts there are to the distribution they receive from their managed fund, potentially including interest income, fully franked income, unfranked income and capital gains. 

Holding shares directly offers the investor greater control of capital gains tax events, even allowing them to make specific decisions related to their own circumstances (for example, delaying a sale in one financial year because they know they will earn less income in the next year, and therefore face a lower tax rate). 

Separately managed accounts have grown in popularity, in part for their ability to offer investors control over capital gains – giving investors access to an investment management service, while owning the shares directly in their own name.

Superannuation and Capital Gains

Superannuation provides two key advantages for people looking to manage capital gains. 

The first is that the lower tax regime of superannuation means any capital gains realised in superannuation ‘leaks' less tax compared to investments held in the name of someone on the average income tax rate or higher. 

Keeping assets that have the expectation of capital gains in superannuation fund makes sense – provided you can forgo access to these funds until you reach your preservation age.  This strategy makes even more sense for people with the ability to transfer assets from the ‘accumulation' phase of superannuation to the ‘pension' phase, where the tax rate for capital gains falls to 0 per cent. 

Because of this, deferring capital gains tax sales until a superannuation fund is in pension mode is potentially a powerful strategy.

For those facing capital gains tax on assets outside of superannuation, the recent change to laws that allow people to claim a tax-deduction for a personal contribution to superannuation provides a great way for people who face the 32.5 per cent income tax bracket or higher to more than halve their tax liability on the sale of an asset.

Let us consider the following scenario, based on the purchase and sale of shares that were held for a period of more than 12 months:

Let's assume that this person is paying income tax at the rate of 32.5 per cent. They face a tax liability of $3,250 based on the $10,000 capital gains that they have to add to their personal income from the sale of these shares (excluding Medicare). 

However, if they make a tax-deductible contribution to superannuation of $10,000, this effectively reduces their taxable income by the amount of the capital gain, so there is no tax payable outside of superannuation. 

Instead, they would pay 15 per cent contributions tax, or $1,500, more than halving the tax payable.  In thinking about this strategy, you do need to keep in mind the concessional superannuation contributions limits (now $25,000 per annum).

Thinking About Financial Year Income and Capital Gains Tax

An interesting element of capital gains tax for individuals is that the amount of the capital gain is added to their income – meaning that a person's income tax bracket is a key element in the capital gains tax equation.

If there is an opportunity to realise a capital gain in a financial year where you have lower income tax, for example if you having a career break or deferring the capital gain until after retirement, it may well be worth deferring a capital gain until then.

Similar to this, if you have a capital gain that increases your taxable income into the next tax bracket in a financial year, it is worth considering whether deferring the asset sale into a year where you have less income, and therefore the gain will be taxed in a lower bracket, is a strategy worth thinking about.

Conclusion

A perfect scenario for investors is to own assets that they don't have to sell and that provide increasing income and value over time. 

This, of course, is unrealistic and makes capital gains tax a reality for most investors.  Thinking through the ownership of investments likely to provide capital gains, the timing of investment sales and looking to offset capital gains tax with tax deductible superannuation contributions are all strategies that can be used to moderate the amount of tax payable on the sale of assets.