How to manage your taxes when you invest in shares

If you dabble regularly in share investment, the question might arise as to whether you have moved beyond being a passive investor in shares to someone who actively trades shares.

It's a crucial question to consider because it will determine how you're taxed on any profits or losses you make on your share portfolio.

A share investor is generally someone who buys shares with the intention of holding them long-term to generate profit through growth in value and income through dividends.

If you're a share investor - and most people who buy and sell shares are regarded as investors by the ATO, irrespective of how the investors see themselves - any profits or losses you make from selling your shares will be governed by the capital gains tax rules which means that profits and losses will only arise when shares are physically disposed of.

A share trader, i.e. someone carrying on the business of dealing in shares, will be marked out as someone who buys and sells shares purely for short term profits and will show some or all of the following hallmarks:

1. A substantial volume of transactions;

2. A clear profit-making intent;

3. A substantial commitment to running activities in a business-like manner (e.g. a large investment of capital, a well-developed business plan, extensive research and properly maintained books and records).

In tax terms, someone who buys and sells shares as part of a business will treat those assets as trading stock, and gains or losses on them will be treated as ordinary income rather than capital gains.

The key tax advantage of being a share trader arises if you make losses, which can then be offset against other income. In valuing trading stock at year-end, each share can be brought into account at either cost, market value or replacement value.

Where market value is less than the original cost, this means that an immediate trading loss can be crystallised and deducted.

In short, unrealised losses can be booked immediately but unrealised gains are held back. It's entirely up to you which method you use to value your year-end portfolio but there is of course a need for consistency; if you choose to value shares in a Pty Ltd at market value in year one, you need to use a consistent basis in year two; you can't chop-and-change valuation methods to suit your particular circumstances in each year.

If you are taxed as a share investor, any losses will be treated on a capital account which makes it difficult to get the full benefit. Capital losses can only be offset against other capital gains arising either in the same year or a future year.

By contrast, the key advantage for a share investor comes when you are showing a profit, which will be taxed as a capital gain. The 50% CGT discount will apply to all shares sold that you have held on to for more than a year - the effect of which is to reduce the tax you pay on your capital gains by half.

If you're not sure whether you're an investor or a trader, you might need to apply to the ATO for a private ruling.

Deductions are available

For both investors and traders, you will pay income tax on any dividends that you receive while you hold the shares, against which you can offset:

• interest on borrowed funds where you have financed your portfolio using those funds
• borrowing costs incurred in arranging finance, such as legal expenses, loan establishment fees, etc (deductible over five years or the term of the loan, whichever is shorter, unless the amount is $100 or less in which case it's immediately deductible)
• bank charges for bank accounts to manage your investment income and expenses
• management fees or retainers paid to a financial planner (but not the initial costs of drawing up an investment plan)
• the cost of running a home office to manage your share portfolio (including telephone, computer and internet expenses),
• the cost of investment-related journals and subscriptions
• costs of obtaining tax advice
• travel costs associated with your share portfolio, such as trips to see your financial planner or stockbroker, or the cost of attending AGMs

You can also claim depreciation on any assets used to manage your portfolio, such as computers, laptops, and so on, with the deduction apportioned between private/domestic use and use in managing your shares.

Immediate deductions can be claimed for depreciating assets that cost less than $300.

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