Critical capital gains tax considerations for SMSFs

Income such as dividends, interest or rent derived from the ownership of assets by super funds (including SMSFs) is recognised as ordinary income of the fund in broadly the same way as other taxpayers. However, when it comes to gains and losses from the disposal of assets, there are some key differences in the tax implications when compared to other arrangements.

Importantly, the primary code for calculating gains or losses for tax purposes with super funds is the capital gains tax provisions. As a result, super funds are specifically excluded from:

• applying the provisions which would allow the recognition of a realised capital gain as ordinary income
• utilising a realised capital loss as a deductible expense against ordinary or statutory income of the fund

It does not matter how often or regularly a super fund trustee disposes of assets, the resulting gain or loss will be treated as a capital gain or capital loss for tax purposes, and the tax liability of the transaction calculated accordingly.

Other key differences are that:

• assets acquired by a super fund prior to 20 September 1985 are not exempt from CGT on disposal
• the cost base for long-held assets will be the larger of the market value on 30 June 1988 (when taxation of super funds commenced) and the original purchase price
• the cost base for assets acquired on or after 30 June 1988 is the purchase price
• the maximum tax rate payable on realised capital gains in super is 15 per cent
• where assets are owned for more than 12 months, the discount available is 33 per cent, which reduces the effective maximum rate payable on realised capital gains to 10 per cent

Gains made in pension phase

While the provisions outlined above generally apply during the accumulation phase, CGT is usually not payable when assets used to support a super pension are sold by the fund. This is because, so long as the pension was validly commenced and the payment standards are met, no tax is payable on fund earnings, including capital gains derived from assets supporting the pension liability. This exempt income is known as exempt current pension income (ECPI).

Gains made by SMSFs in pension phase

If an SMSF makes capital gains or losses, the CGT implications depend on whether the segregated or unsegregated method is used to determine ECPI.

If the SMSF only has segregated pension assets and these assets are disposed of, any realised capital gains or capital losses are ignored. Realised capital losses arising from the disposal of segregated assets, for example, cannot be offset against any other realised capital gains derived by the SMSF.

Conversely, if the SMSF uses the unsegregated method to determine ECPI, capital gains and capital losses do need to be accounted for. More specifically:

• realised capital losses are not included as deductions against ordinary income when calculating taxable income and may only be applied against realised capital gains
• net capital losses can be carried forward in full each year until they are offset against assessable capital gains in later years
• any net capital gain is added to the SMSF's assessable income before working out how much of that assessable income is tax exempt, as determined by an actuary

Clients should be encouraged to discuss the best approach for calculating ECPI with their taxation adviser in order to determine the better tax outcome.

Example: CGT implications on asset disposal

Rob and Leah have an SMSF, which purchased a property in 2002 for $500,000 that is now worth $1.2 million. Rob started an account-based pension in 2010 at age 55 and the property is segregated from other fund assets as being attributable to his pension. Leah is currently aged 52 and her money is therefore still in the accumulation phase.

If Rob and Leah decide to sell the property in their capacity as trustees, no CGT will be payable on the sale proceeds as the property is segregated in Rob’s pension. However, if the fund had used the unsegregated method, then only that portion of the property deemed to be supporting Rob’s pension would be tax-exempt.

Peter Hogan, national manager SMSF Advice with MLC Advice Solutions