Investing and Tax

Certain investment opportunities offer tax advantages that can expedite your journey towards your financial objectives. However, these tax benefits should not be the sole determinant of your investment choices.

Much like other forms of income and property, investment income is also subject to taxation at your marginal tax rate. This encompasses the returns on your investments, which may come in the form of dividends, interest, rent, capital gains, and distributions from managed funds. Additionally, tax deductions are generally available for the expenses incurred while managing, buying, and selling an investment.

Navigating the complexities of investment income taxation can be daunting, given the multifaceted rules and regulations stipulated by the Australian Taxation Office (ATO). Therefore, it may be prudent to enlist the services of a professional accountant to assist in managing your taxation obligations effectively.

Nevertheless, it’s essential for investors to gain a fundamental understanding of several key aspects of investment-related taxation, which include:

Capital Gains and Losses

Capital gains refer to the profit realized when you sell an investment at a price higher than its purchase cost. When such a scenario unfolds, all your capital gains must be declared in your tax returns for the year the investment was sold. Capital gains are subject to marginal tax rates. However, if you held the investment for more than 12 months before selling it, you may be eligible for a capital gains tax discount. Under this provision, only half of your capital gain would be subjected to taxation.

Conversely, capital losses arise when you sell an investment for a price lower than its acquisition cost. These losses can serve to offset the capital gains incurred in the same year. Alternatively, you can carry forward this loss to counterbalance future capital gains.

Gearing

Gearing, in the context of investing, refers to the process of borrowing money to fund investments. The outcome of such a strategy can either be positive or negative.

Positive gearing arises when the income generated from the borrowed funds surpasses the cost of the investment, including interest and other related expenses. This implies that your investment is yielding a profit, thereby increasing your overall income. As a result, you are positively geared. However, it’s crucial to remember that this increased income will also elevate your tax liability, as income from investments is subject to taxation.

On the other hand, negative gearing transpires when the return on investment fails to cover the cost associated with the investment, including interest on the borrowed funds. This results in a loss, and you’re considered to be negatively geared. Interestingly, many investors deliberately seek out negatively geared investments. The rationale behind this is that the incurred loss can be claimed as a tax deduction, offsetting other taxable income and thereby reducing overall tax liabilities. This strategy typically hinges on the expectation that the investment will appreciate over time, eventually leading to a capital gain when the investment is sold.

It’s worth noting that while gearing can amplify potential returns, it also escalates the level of risk. As such, careful consideration and consultation with a financial advisor is recommended before undertaking a gearing strategy.

Tax-effective Investments

Investments can be assessed on the basis of their tax-effectiveness, where the tax burden on the investment income is less than your marginal tax rate. When evaluating potential investments, considering tax effectiveness is advantageous, but it should not be the primary determinant. Among tax-effective investments, the following stand out:

Superannuation: Recognised as one of the most efficient ways to accumulate savings for retirement, superannuation is highly tax effective. This is due to tax incentives established to motivate individuals to save through superannuation. Some of the incentives include:

  • A concessional tax rate of 10% on capital gains
  • A maximum tax rate of 15% on investment income
  • No tax on super withdrawals for most individuals aged 60 and above
  • A 15% tax rate on super contributions made by employers and their salary sacrifice contributions for those earning below $250,000
  • Zero tax on investment earnings once you commence a superannuation pension.

Insurance Bonds: If your investment horizon is long-term, specifically 10 years or more, insurance bonds issued by insurance companies can be tax-effective, provided certain conditions are met. Unlike other investment income, income from insurance bonds does not need to be declared on your tax return. Moreover, if the bond is held for more than 10 years, the returns are tax-free.

When it comes to declaring your investment income on your tax return, maintaining accurate and comprehensive records is essential. This ensures that you are well-prepared when tax time arrives, reducing potential headaches and ensuring you’re able to take advantage of all relevant deductions and credits.

Please note that tax laws are complex and vary from individual to individual. Always consult with a tax professional to ensure you are meeting your legal obligations and optimizing your tax position.

We have provided some helpful links to provide more information on this topic

  1. Australian Taxation Office: Tax on Investments
  2. MoneySmart: How Tax Works
  3. KPMG: Understanding Tax
  4. Tax Institute: Navigating Investment Taxes
  5. H&R Block: Investment Income and Taxes