Managing capital gains in your SMSF portfolio

In this guide

What are capital gains and CGT?
How CGT liabilities are calculated in an SMSF
Strategies for managing capital gains and losses in your SMSF

When you invest you make capital gains when asset values increase and capital losses when their values fall.

While the object of investing is to build your capital, the downside of making significant capital gains is that you can end up with a tax liability when the assets are sold.

When it comes to your SMSF, the right strategies can help you to effectively manage CGT within your portfolio and reduce its impact on your super balance.

Important

If you are considering using any strategy to reduce your tax bill, you should always speak to a registered tax agent or accountant before taking any action.

CGT is a very complex area of taxation law and a qualified tax professional will be able to help you successfully navigate the rules and may also be able to determine if you can use any other tax minimisation strategies.

This information is of a general nature only and cannot be considered financial advice.

What are capital gains and CGT?

Before rushing into the strategies, it’s worth quickly brushing up on the basics of how CGT works. CGT is part of the normal income tax of your SMSF (or of your income tax for gains you make outside super) and isn’t a separate tax. Under tax law, whenever you sell an asset and make a capital gain, you’re usually required to pay some tax on the capital gain you’ve made since purchasing the asset.

For example, if super fund A bought asset X three years ago for $100,000 but sells it for $120,000, the capital gain made on that asset is $20,000. Conversely, if the fund sells asset X for $80,000, it suffers a capital loss of $20,000.

When your capital gain is calculated, you’re permitted to offset it against any capital losses to determine your net tax position, on which the amount of CGT is calculated. Generally, there is no time limit on how long a capital loss can be held to offset future capital gains.

The ATO defines a net capital gain as:

total capital gain for the year

less

total capital losses for that year and any unapplied capital losses from earlier years

less

CGT discount and any other concessions.

How CGT liabilities are calculated in an SMSF

During the process of buying and selling assets during a financial year, SMSFs usually generate both capital gains and capital losses. The CGT liability for any capital gain depends on whether the fund is in accumulation or retirement phase and whether there are fund members in each of those phases:

a. Accumulation phase CGT rules

If an SMSF is wholly in accumulation phase, it will pay CGT on the fund’s annual net capital gain. The net gain is treated as income for tax purposes, so it will be taxed at the same rate (15%) as other income in the fund. If an asset is held for more than 12 months, any capital gain is eligible for a discount of one-third, resulting in an effective tax rate of 10%.

Capital losses in SMSFs in accumulation phase can only be used to offset capital gains and cannot be used to offset any other income. A capital loss can be carried forward to future years in accumulation phase and used to offset capital gains at that time.

b. Retirement phase CGT rules

Because income earned in retirement phase is tax free, if the asset is sold in retirement phase, the SMSF will have no CGT liability on the capital gain.

Case study 1

Jeff has an SMSF in accumulation phase and has made capital gains of $10,000 on the sale of SMSF shares this year. The shares were held by his fund for longer than 12 months, so his SMSF is eligible for the CGT discount. The fund also has an unapplied capital loss of $3,000 from earlier years that can be offset against this year’s capital gain.

The net capital gain for Jeff’s SMSF is calculated as follows:

Net capital gain = $10,000 – $3,000 = $7,000

Taxable CGT amount = $7,000 – ($7,000 x 1/3 discount)

= $7,000 – $2,333.33

= $4,666.67

This net capital gain amount will be added to the SMSF’s income and taxed at 15% or a tax liability of $700 ($4,666.67 x 0.15 = $700).

Note: To be eligible for the concessional tax rate of 15% on all income earned, an SMSF must be a complying fund adhering to all the legal requirements for an SMSF. If it’s non-complying, tax is levied at 45%.

Strategies for managing capital gains and losses in your SMSF

Strategy 1: Deferring capital gains until retirement

Deferring capital gains involves simply putting off the sale of an asset on which you expect to make a capital gain until all the members of the SMSF are in retirement phase.

Case study 2

Rajiv is expecting to retire next year. His SMSF has a balance of $900,000 and is wholly in accumulation phase. Within that balance is a parcel of shares bought for $10,000 15 years ago and now worth $30,000.

If Rajiv sold the parcel of shares today, and he had no other capital gains or losses, he would have a tax liability of $2,000:

$30,000 – $10,000 = $20,000 capital gain

$20,000 – ($20,000 x 1/3 discount) = $13,333.33

$13,333.33 x 0.15 = $2,000

If Rajiv instead held the asset for one more year and sold the parcel of shares once his fund was wholly in retirement phase, the tax liability would become zero and he would be $2,000 better off.

Rajiv needs to consider other factors, however, such as the investment outlook for the asset. If the investment was to fall in value by 50% before he retired, for example, his current tax liability of $2,000 would pale in comparison to the loss of $15,000 to the SMSF.

Strategy 2: Using a capital gain to offset a capital loss

Capital losses from SMSF asset sales can be held until the fund experiences a capital gain. If the fund is expecting a capital loss in a particular year (such as from selling a poorly performing asset), it’s sensible to realise a capital gain in the same financial year.

This is very useful when all the fund members are getting close to retiring, as carrying forward capital losses is worthless when the SMSF moves wholly from accumulation to wholly retirement phase and becomes tax free.

Case study 3

Bill and Bo have an SMSF and are both two years away from retiring. They have an investment in a bundle of XYZ shares which they bought for $10,000 two years ago, but the value has now fallen to $9,000. They want to sell that bundle of shares before they fall in value further but, if they do, the fund will experience a capital loss of $1,000.

They also have an investment in ABC shares, which they bought three years ago for $10,000 and currently worth $11,000 but have stayed at that value for the past 12 months. They have been discussing whether or not to wait until they both retire to sell both parcels of shares so as not to realise any capital gains.

They finally decide to sell both parcels of shares this year with the capital gain completely offset by the capital loss. They then use the proceeds to buy $20,000 worth of TUV shares, which has excellent growth prospects. That bundle of shares increases in value over the next four years to $25,000. When they sell them in retirement phase for a net capital gain of $5,000, it incurs no tax. This is potentially a better outcome than if they held onto their previous two parcels of shares and sold them in retirement phase.