- Tax efficient investing is about paying no more tax than you need to.
- You may have to pay income tax on investment earnings, and capital gains tax when you sell an investment asset.
- There are many costs you can claim against your investment income, including management fees, interest on debt and more.
You’ve put money aside to invest and made some smart choices. Now your wealth is growing nicely, which is just as it should be. But it’s no use getting grumpy when the ATO lay claim to your windfall. Tax is tax and it’s got to be paid.
On the other hand, there’s no harm in taking steps to pay no more tax than you need to. Here are some ways to be a tax samurai with investments and still tread the path of righteousness with the ATO. Tax is complicated and what we’ve tried to do here is point you in the right direction—we highly recommend seeking individual tax advice before taking any action.
What and how you’ll pay – income tax
Whether earned in Australia or overseas, investment income is part of your tax liability, and you’ll need to declare it on your tax return. Unlike your salary, you generally won’t be paying tax on investments throughout the financial year. So when you get your notice of assessment from the ATO, you’ll need ready cash to settle any tax owing.
With some types of investments more of your return comes from its overall growth in value rather than income earned. Buying an investment property in Australia, for example, is generally expected to bring more wealth from its rising market value than from rental income. By taking this path with investing, you delay facing up to the tax burden from your investment and potentially pay less tax as a result. But you’re also tying up money for longer and may not benefit from a steady flow of income from your investment.
For some investments, tax is paid on earnings before they’re distributed to you. But that doesn’t always mean you’re in the clear for your tax liability on that income. Depending on the type of investment and your marginal tax rate, you may still have to declare the income on your tax return, and benefit from an offset or credit for tax already paid.
When you’re looking at the returns expected for different investments, tax is a major cost to factor in. So you need to be very clear just how much of the income you receive will be liable for tax and when you’ll need to pay. By taking this into account, you can make a fair comparison between different investment options.
What you can claim – income tax deductions
In the eyes of the ATO, income from investing is a bit like money earned by a business or individual. And that means investing costs can be claimed as a deduction. But there are rules around what can be claimed and keeping detailed records of all costs is essential:
- Borrowing – whether it’s a mortgage on property or money borrowed to buy shares, the interest you’re paying on investment debt is tax deductible.
- Account-keeping fees – fees charged on any accounts you hold for investment purposes can also be claimed. You might have a cash management account for example, as a source of funds to invest, or hold investment earnings until they are reinvested.
- Managing investments – there are all sorts of expenses you can claim as costs when it comes to managing investments. From financial advice fees directly related to the income-producing assets, to plumbing repairs for your investment property, if it’s directly related to the investment and okay by the ATO, it can reduce the tax on your income.
- Franking credits – when listed companies in Australia pay dividends, tax the business has already paid on their earnings is credited to the shareholder, stopping double taxation. This is called a ‘franking credit’ and it’s another offset that tips the scales in your favour for your tax return.
What and how you’ll pay – capital gains tax
Capital gains tax (CGT) is just another form of income tax but it applies to the net amount you pocket when selling an investment asset. So whether that’s shares or property, you’ll pay CGT on the difference between what you paid and what you sold the asset for, minus any costs associated with buying or keeping the asset. Hold the assets for longer than 12 months and you pay tax only on half the gain. Brokerage fees and stamp duty for buying shares, for example, can’t be claimed as an income tax deduction. But they can be included in the calculations for the capital gain (or loss) when you come to sell those shares. As with your other investment costs, it’s very important to record anything you might want to claim as a cost of ownership.
Capital gains are declared on your tax return in the year you enter into a contract to sell the asset, rather than when you actually receive the cash.
What you can claim – capital losses
Selling an asset at a loss isn’t usually an investment outcome you’d welcome. But if you do stand to make a healthy capital gain in a given year, a capital loss can offset your CGT bill. Capital losses can also be carried forward and offset against your CGT liability in future years.
Remember though you can’t game the system. The ATO warns investors against what’s called ‘wash sale’ activity. This is where an investor sells an asset at a capital loss for tax purposes, only to buy it again in the next financial year.
And that, investor friends, shows the difference between tax efficiency and avoidance in the eyes of the ATO. They don’t want you to be paying any more tax than you need to, but get too strategic or sneaky it and they’ll come down on you hard.
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© Morningstar Investment Management Australian Limited (‘Morningstar’) and any related bodies corporate that are involved in the document’s creation. Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Morningstar nor its third-party providers accept responsibility for any inaccuracy or for investment decisions by any person on the basis of the information included. Past performance is not a reliable indicator of future performance. Morningstar does not guarantee the performance of any investment. Any general advice has been prepared without reference to your investment objectives, financial situation or needs. You should consider the advice in light of these matters and if applicable, the relevant disclosure document before making any decision to invest. Refer to our Financial Services Guide for more information.