As property accountants at Investax, we receive a variety of inquiries from clients regarding capital gains and capital losses. Every investment property inevitably results in either a capital gain or a capital loss when sold. While capital gain is generally calculated as the sale proceeds minus the cost of acquiring the property, it’s the inclusion or exclusion of certain costs that ultimately determines the final capital gain or loss. In this case study, we will explore which expenses cannot be claimed to increase a capital loss and clarify common misconceptions about deductible and non-deductible costs.

Overview

Liam and Emma, through their family discretionary trust, purchased a unit in Western Australia in 2018 for investment purposes. Their plan was to rent it out and benefit from capital growth over time. Initially, the property was rented out for two years. However, in 2020, when Emma became pregnant, they decided to move into the property to be closer to their parents for support.

By 2025, due to changes in their financial situation and the need for a larger home, they decided to sell the property. Unfortunately, due to a downturn in the local property market, the unit could only be sold for $700,000, resulting in a capital gain of $100,000, as the original purchase price was $600,000.

Before proceeding with the sale, they approached Investax with a few key questions:

Will they qualify for a capital gains tax (CGT) exemption since they lived in the property from 2021 until 2025, prior to the sale date?
If they do not qualify for the CGT exemption, can they claim any expenses incurred while living in the property? Specifically, they have undertaken repairs and maintenance, including a paint job, in anticipation of the sale.
What will be their Capital Gain Tax (CGT)?

Assessing the Costs Incurred Throughout Ownership

Beyond the purchase price, several other costs were incurred throughout their ownership of the property. These include –

Stamp duty: $22,500
Legal fees (purchase): $2,000
Buyer’s agent fees at purchase: $14,000
Real estate agent commission at sale: $12,000
Legal fees at sale: $2,500

While living in the property, they incurred the following non-deductible expenses:

Council rates: $10,000
Water rates: $7,200
Insurance premiums: $8,000
Bank interest $120,000

Question (I) – Will they qualify for a capital gains tax (CGT) exemption?

No, Liam and Emma will not qualify for the main residence exemption on the capital gain, even though they lived in the property as their primary residence from 2021 to 2025.

The main residence exemption under Australian tax law applies only to individuals who own the property in their personal name. However, in this case, the unit is owned by a discretionary trust, not by Liam and Emma personally. The main residence exemption does not extend to properties held within discretionary trusts, companies, or unit trusts, regardless of whether the beneficiaries or controllers of the trust live in the property.

Question (ii) – Since They Do Not Get CGT Exemption, What Happens to the Costs They Incurred and What Will Be Their Capital Gain?

Liam and Emma do not qualify for the CGT exemption since the property is owned by their discretionary trust. As a result, they need to calculate their capital gain or loss. To determine a capital gain or loss from the sale of a property, it is essential to calculate the accurate cost base of the asset. The cost base includes the purchase price of the property along with additional expenses incurred in acquiring, holding, and disposing of it. There are five key elements that make up the cost base, and all of them can be included when calculating a capital gain. However, the third element (ownership costs) cannot be used to create or increase a capital loss—it can only be applied up to the point where the capital gain is reduced to zero.

The Cost base elements are:

(1) the money paid, or property given for the asset,

(2) incidental costs of acquisition or disposal,

(3) ownership costs such as rates, land taxes, and non-deductible loan interest, (

4) capital costs that enhance or preserve the asset’s value, and

(5) costs related to preserving or defending ownership rights.

However, expenses that are deductible for income tax purposes, such as capital works deductions, cannot be included in the cost base.

Question (iii) – Step-by-Step Breakdown of Capital Gain Calculation

1. Estimated Sale Price

Estimated Sale Price (Capital Proceeds) is $700,000

2. Cost Base Calculation

✅ Money Paid or Property Given for the Asset

Purchase price (2018): $600,000
Stamp duty: $22,500
Legal fees (purchase): $2,000

✅ Incidental Costs of Acquisition and Sale

Buyer’s agent fees at purchase: $14,000
Real estate agent commission at sale: $12,000
Legal fees at sale: $2,500

3. Total Cost Base Before Applying Ownership Costs

The total cost base before applying ownership costs is $653,000, calculated by adding up all the above costs.

i.e., $600,000 (purchase price) + $22,500 (stamp duty) + $2,000 (legal fees) + $14,000 (buyer’s agent fees) + $12,000 (real estate commission) + $2,500 (legal fees at sale)

4. Initial Capital Gain Calculation

Sale price ($700,000) – Cost base before ownership costs ($653,000)

= $47,000 capital gain

This $47,000 capital gain is what we initially calculate before considering ownership costs (third element).

5. Applying Ownership Costs

✅ Ownership Costs (Third Element – Can Be Included but Only Up to $47,000)

Council rates: $10,000
Water rates: $7,200
Insurance premiums: $8,000
Non-deductible interest while living in the property: $120,000

🚫 Restriction on Ownership Costs

Since ownership costs cannot create a capital loss, we can only use up to $47,000 of ownership costs.
The remaining $98,200 of ownership costs cannot be used to further increase the Capital Loss.

6. Final Capital Gain Calculation After Applying Ownership Costs

Initial capital gain ($47,000) – Ownership costs applied ($47,000) = $0 taxable capital gain

Conclusion

Calculating capital gains tax correctly requires a thorough understanding of what expenses can and cannot be included in the cost base. As seen in Liam and Emma’s case, while certain ownership costs can help reduce a capital gain, they cannot create or increase a capital loss. This becomes even more critical when holding vacant land for an extended period, as ongoing holding costs such as council rates, water rates, and interest expenses may not be recoverable if the property is sold at a loss. Without careful planning, owners risk losing all the third-element costs, further impacting their financial position.

Given these complexities, structuring property ownership correctly and understanding the tax implications from the outset is crucial. Whether you are purchasing a property, holding vacant land, or planning a sale, consulting with an experienced property accountant can help you optimise your tax position and avoid costly mistakes.

At Investax, we specialise in providing tailored tax and structuring advice for property investors. Contact us today to ensure your property investment is structured effectively and tax-efficiently.

Reference: ATO – Cost Base of Assets