Written by Ivan Fletcher
CONVERTING A CAPITAL LOSS INTO A TAX DEDUCTION
As we get older and access to Super gets closer, an appropriate strategy for consideration is to start converting non super assets into super assets and collecting either additional tax refunds or reduced tax on earnings (or ideally both).
This strategy involves selling personally owned growth assets such as shares or managed funds with nil to low CGT impact (on the back of recent market losses over the last 2 years) and use those funds to make deductible personal super contributions and boost your tax refund and reduce annual tax on your investments for the longer term.
1. You have unused capacity in your $27,500 Concessional Contribution CAP.
If your Total Super Balance (across all your super and pension accounts) is under $500,000 as at 30/6/23, then you may be able to contribute much more to super by utilising any unused CAP accumulated over the last 5 financial years.
2. You have positive equity (net of debt) in shares or managed funds (or similar liquid assets) sitting in an unrealised Capital loss (or at least minimal Capital gain) position.
You do not require access to these funds prior to age 65 or retirement (whichever comes first).
1. Concessional Contribution Capacity
Hopefully you are all now aware that you can give yourself a tax deduction by making a personal contribution to your own super. This is well documented in past Hudson Reports.
Provided you are within the qualifying criteria, you can make personal contributions within the regular $27,500 CAP for personal contributions and claim a tax deduction against your Marginal Tax Bracket.
Neil expects to earn $100,000 for the financial year and receive a total of $11,000 in employer (SG) contributions. He has not done any salary sacrifice to super. This means Neil has a further $16,500 available in unused Concessional contributions for the 2023/24 tax year.
Neil can therefore make a personal contribution (from his own bank account) to his super fund and claim a tax deduction in his personal tax return.
In this example, however Neil has 2 children in private schooling and there is no spare cash from the household income to cover a $16,500 contribution to super but he does have some investments that he no longer feels he needs immediate access to.
2. Unrealised Capital Loss Position
Neil has a $50,000 portfolio of managed funds and direct shares (with nil debt). Whilst the overall portfolio has a net unrealised Gain position, some of the investments are in an unrealised Tax Loss position.
$20,000 of investments have an unrealised LOSS of $1,500
$30,000 of investments have an unrealised GAIN of $3,000
$50,000 Total Investments with Overall net Gain of $1,500
If they were to sell $16,500 of select investments from the unrealised Loss part of the portfolio, there would be no CGT to pay and the sale proceeds could be used to fund a personal super contribution.
Opportunity – The Financial year of 2022 saw large distributions for many managed funds which resulted in addental tax in that year. In some cases this means that you may have already paid taxes on gains accumulated over past years and could trigger a capital loss upon sale (For tax purposes) – which is a perfect scenario for this strategy.
Warning – If your portfolio is originally funded by debt, then the effectiveness of this strategy may be significantly reduced or not viable. If your loan value is higher than your investments valuation then this strategy is likely unviable. You will need to consult with a tax agent on whether part of your portfolio could qualify for this transaction without compromising the tax deductible interest on the loan.
Order Of Events For A Successful Strategy
- Assess the unrealised gain / loss position of your existing portfolio. Broker Reports of Managed fund reports may make this task considerably easier where available.
- Consult with your tax agent if you have borrowings involved in your existing portfolio.
You will need to have investments of greater value than your associated borrowings.
- Hand pick investments that you know will collectively AVOID a Capital Gain overall and then sell to cash.
- Make a personal contribution to your super within the contribution Caps the above events must all happen in the same financial year – preferably within the same week.
- If eligible Lodge a Notice of Intent with your Super fund subject to your Superannuation
(In Neils case this was $16,500 after allowing for his Employer contributions).
- Provide the Confirmation of your Personal Concessional contribution (which will come from your super fund) to your tax agent to ensure you claim the deduction in your tax return. This is THE MOST IMPORTANT STEP to ensure you gain the tax benefit.
The Tax Benefit
$5,693 Additional Tax Refund ($16,500 x 34.5% Marginal tax Rate inclusive of Medicare levy).
($2,475) Less Contributions tax Paid by Super Fund ($16,500 x 15%)
$3,218 Net Tax Saving
This is the equivalent of a 19.5% net return (via tax savings) on the strategy.
Additional Long Term Tax Benefits
In addition to the above ONE OFF tax saving, your investments are now potentially in a lower tax environment.
In Neils case all investment income was being assessed at his 34.5% Marginal tax rate.
Inside super the same investments would attract only 15% tax on income (again a 19.5% advantage that is compounded year on year. Capital Gains would also be taxed lower in Neil’s case.
Other Considerations – Alternative use of funds
The funds will not be 100% accessible in super until a trigger for release is met such as age 65 or retirement (after age 60) but are partially accessible from age 60 under “Transition To Retirement” Rules regardless of employment.
If the non super investments are intended to fund a personal goal such as a child’s wedding, car upgrade, renovation or once in a life time holiday – then this may be a show stopper for this strategy.
This strategy is often cyclical in that for managed funds in particular it is most suited to the year(s) following a combination of large distributions (as per year ended June 2022) and a subsequent correction in the share market (which happened around that same time).