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Selling SMSF assets in the most tax-efficient way

Melanie Dunn  |  26 Sep 2018Text size  Decrease  Increase  |  
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You should pay careful attention to the timing of any SMSF asset sales, because regulatory changes can affect capital gains tax treatment, according to Melanie Dunn.

The net capital gain of an SMSF for an income year forms part of the fund’s assessable income. How capital gains or losses are taxed will depend on whether any of the fund members are in retirement phase, and the method the fund must use to claim exempt current pension income (ECPI).

Determining capital gains tax examption

For an SMSF with no retirement-phase interests, such as accumulation or non-retirement phase transition to retirement income stream (TRIS) accounts, all net capital gains will be taxable and capital losses can be carried forward.

Where an SMSF has retirement phase interests, we must first determine which method the fund will use to calculate capital gains taxation. These options include the proportionate method, segregated method, or a combination of the two.

SMSFs solely in retirement phase for the entire income year – including account-based pensions, TRIS in retirement phase and market-linked pensions – will disregard capital gains and losses.

This means that capital losses carried forward from previous years don't need to be offset against current year capital gains realised when solely in retirement phase – even if the fund is using the proportionate method for ECPI.

However, where an SMSF has both non-retirement phase and retirement phase accounts in the income year, the taxation of capital gains will depend on the retirement phase status of the fund at the time of sale.

The actuarial proportion will no longer automatically apply to the total net capital gains over the income year.

When retirement and non-retirement phases overlap

If the fund had a non-retirement phase account at all times in the income year, or had disregarded small fund assets, then the actuarial exempt income proportion will apply to the net capital gain over the whole income year.

If the fund had net capital losses, these can be carried forward. This is the same treatment as has occurred in previous years. However, if the fund did not have disregarded small fund assets and had periods of the year where assets were solely supporting retirement phase accounts, the fund would be deemed to have segregated current pension assets in those periods.

For a fund in this situation:

  • any capital gains realised when the fund had a non-retirement phase interest would have the actuarial exempt income proportion apply
  • any losses could be carried forward
  • any gains or losses received when the fund was deemed to be segregated would be disregarded.

This impacts the taxation of any capital gains in two ways:

  • The actuarial exempt income proportion will be lower than would have been the case in previous years. This is because the assets deemed to be segregated pension assets are excluded from the actuarial calculation
  • The timing of capital gains and losses being realised becomes important

Selling assets where the fund has deemed segregation

A fund cannot choose to use the proportionate or segregated method based on what will give the best tax outcome. How capital gains are taxed depends on the decisions made by trustees before the start of the income year, and the transactions that occurred within this period.

Trustees should plan in advance if they anticipate the fund might have deemed periods, to better manage the tax outcomes on capital gains.

This impacts the taxation of any capital gains in two ways, as outlined in the following scenario:

A single SMSF member, Cameron, had $1.5 million in accumulation phase at 1 July 2017. The fund owns an investment property, and to improve liquidity, the fund was looking to this asset in the 2017-18 financial year.

Cameron retired in October 2017 and commenced an account-based pension using his accumulated savings. He drew only the minimum pension required.

In prior income years, it wouldn't have mattered when Cameron sold the investment property in the income year. The fund could have obtained an actuarial certificate, and the exempt income proportion would apply to that net capital gain – which would be around 75 per cent tax exempt.

However, from the 2017-18 income year, we need to account for deemed segregation. When Cameron retires and moves his balance into a pension, the fund assets at that time will be solely supporting retirement phase accounts.

The fund’s assets would be deemed to be segregated current pension assets. Its liabilities over the income year would be as shown in the below chart.

house tax smsf

This highlights that the fund shifted once Cameron retired, from being entirely in accumulation phase, to being entirely within retirement phase. The fund would be deemed as having segregated current pension assets once he retires in October.

If Cameron had sold his property early in the income year before he retired, the capital gain would then be taxed under the proportionate method, excluding any segregated pension assets.

In this case, once we exclude the segregated pension assets (in blue above) the fund has no other retirement phase accounts and will have an exempt income proportion of zero. The capital gain would be entirely taxable.

Cameron could have had a better outcome by understanding the new rules and planning ahead.

Once he sold the asset for a gain prior to retirement, he could have commenced his account-based pension in October, with less than his entire balance.

If he instead left, say, $10 in accumulation, his fund would not be deemed to have moved entirely to retirement phase.

The fund must use the proportionate method and obtain an actuarial certificate to claim the exempt income on the capital gain.

house smsf tax

With a small accumulation balance maintained, the actuarial exempt income proportion of 75 per cent now applies to the capital gain received prior to Cameron retiring in October – a significant tax saving.

Alternatively, if Cameron reached retirement in October and had not yet sold a property, it would be more advantageous to move his entire balance into pension.

When the property was sold later in the year, the capital gain would then be realised in a deemed segregated period, and would be disregarded – making it 100 per cent tax exempt.
Importantly, this strategic thinking also applies to capital losses.

If Cameron had sold an asset at a capital loss after retirement, when he was solely in pension mode, then the loss would be disregarded.

However, if Cameron had an accumulation account at the time the loss was received, then the loss would fall under the proportionate method and could be carried forward.

SMSF trustees, or at least the expert practitioners they rely in, must now understand the implications of ECPI when making investment decisions about fund assets.

ECPI is no longer a matter solely for consideration in arrears when completing the tax return. In order to better manage the tax outcomes, trustees must be more strategic and make plans in advance of divesting assets from their SMSF.

Melanie Dunn, SMSF technical services manager at actuarial firm Accurium, will provide further tips on maximising tax-exemption retirement income next month, when she addresses the Morningstar Individual Investor Conference 2018.


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