Peter finds out his capital gains tax calcs were wrong

Discussion in 'Accounting & Tax' started by Mike A, 27th Feb, 2020.

Join Australia's most dynamic and respected property investment community
  1. Mike A

    Mike A Accountant Business Member

    Joined:
    24th Jun, 2015
    Posts:
    2,252
    Location:
    MELBOURNE
    Bob's mate Peter thought that capital gains tax would apply to the entire sale of his property.

    He found out this wasn't the case.

    Peter had purchased a property.

    The property was a residential property and it had been rented during that time except for relatively short periods where it was empty for reasons beyond his control, but was available for rent through a real estate agent at those times.

    Peter's property was not purchased for the purpose of redevelopment but as an investment.

    Unlike Bob , Peter was not a developer and had never undertaken a development project either personally or through any entity (partnership, trust, etc.)

    Peter then demolished the existing building and replaced it with a duplex being two new residential premises.

    Unfortunately for Peter he calculated his tax payable based on the 50% Capital Gains Tax Discount applying to the entire profit.

    Peter hadn't asked about this thing called "profit from an isolated transaction" and was caught out.

    Proper Planning next time Pete

    #property #propertydevelopment #realestate
     
    ellejay likes this.
  2. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    15,124
    Location:
    Sydney
    This issue is getting a lot of ATO focus since GST withholding was bought in. It arms the ATO with a lot more data. The GST issue escalates the likelyhood a enterprise existed and this is then matched to tax reporting. And imposing the obligations on the buyer makes it harder to avoid.
     
    Mike A likes this.
  3. Rex

    Rex Well-Known Member

    Joined:
    12th Feb, 2018
    Posts:
    813
    Location:
    Perth
    Would Peter have been correct if he'd held on to the duplexes for a period of time, renting them out, before later marketing them for sale?
     
  4. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    15,124
    Location:
    Sydney
    It may depend. A QLD case a few years ago considered this very situation and sales after 9 years were held to be ordinary income as the original intention was to build and construct and sell but market conditions impacted this so the brothers changed their mind and held the dwellings on the land and rented them rather then progressing to develop. Later disposing of the land with those dwellings. The AAT agreed with the ATO that ordinary income applied since the intention at acquisition was to profit.

    If Peter has a defined plan documented prior to construction (often discussed with advisers) to build to rent with no intentions to sell for the forseeable future and then he later sells after several years of renting I see no issues and suitable grounds to defend the ATO suggestion of ordinary income if it arises. I have many such clients and this is all well recorded. Often loan applications etc contain disclosures about intentions to sell and realise profit and reduce debt which can pose a concern.

    One concern for Peter could be a discussed plan about sale. He seeks tax advice and it is suggested GST applies. So he rents them for 5 years then sells three villas'. The deferred sale appears tied to GST and the advice seems to suggest that was a factor he considered. Realisation of three of three dwellings (or both sides of a dupliex) wouldnt assist his assertion that he merely realised CGT assets. But if he had a clear factor that triggered the sale eg Divorce, move offshore etc then it may also be OK. Time is often the best indicator of the capital intentions. The longer the better. But the ATO will usually revert to the intention test.
     
  5. Mike A

    Mike A Accountant Business Member

    Joined:
    24th Jun, 2015
    Posts:
    2,252
    Location:
    MELBOURNE
    As @[email protected] points out the facts for every situation can be the difference between a yes or no.

    One person can do the same thing with slightly different facts and it changes the outcome dramatically.
     
  6. Hamish Blair

    Hamish Blair Well-Known Member

    Joined:
    29th Sep, 2015
    Posts:
    442
    Location:
    Melbourne
    Scenario B: Peter and the family move into one of the duplexes on completion and it becomes his PPOR. The other is rented out for a while.

    Peter then decides to sell the other duplex in order to release the equity and pay down the mortgage on the PPOR.

    GST on sale? CGT discount?
     
  7. Mike A

    Mike A Accountant Business Member

    Joined:
    24th Jun, 2015
    Posts:
    2,252
    Location:
    MELBOURNE
    GST yes.CGT discount would depend on a number of factors such as what was the original intention for the one you sold ?

    Was it always considered that it would need to be sold ?

    Did something change ?

    But that one might have a good case to argue the discount applying.
     
  8. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    15,124
    Location:
    Sydney
    The ATO views on isolated profit include a transaction while is intended to reduce debt. Profit is not monetary profit alone. Why would you redevelop and build a duplex and sell and not have profit making as a intention and an element of a enterprise?

    This may be very different if Peter builds a duplex as a means to accomodate his family and also his elderly parents who soon need aged care and must move out and then he sells. This is a good example of Mike's use of the "change" reference above
     
    Mike A likes this.
  9. danielcannan

    danielcannan Active Member

    Joined:
    21st Feb, 2018
    Posts:
    37
    Location:
    Adelaide
    More information needed - have circumstances changed, what was the original intention, how long was the property rented before sold, or marketed for sale etc.

    Depending on the circumstances, it could be mere realisation of an asset and subject to CGT rules. You may also be able to argue that there is no 'enterprise' for GST purposes.

    It could also be a profit making enterprise, treated as ordinary income and GST payable.
     
    Terry_w likes this.
  10. Hamish Blair

    Hamish Blair Well-Known Member

    Joined:
    29th Sep, 2015
    Posts:
    442
    Location:
    Melbourne
    Peter’s primary objective was to build a home for his family. Buying the block and putting a single dwelling was beyond his financial reach - better to build a duplex, live in one and subdivide the other to rent out and help cover the mortgage.
     
  11. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    15,124
    Location:
    Sydney
    If Peter demonstates the intention for a prolonged period that should be fine. But if Peter sells the non-residence portion early it can question his intention to produce income from rents and lead to a implication that he sought a isolated profit making intent. If he sells the whole duplex TD 92/135 could also apply to his "home"portion and support the enterprise view.

    The recent ATO discussion paper "Draft Property and Construction Website Guidance" is full of examples and often concludes that no conclusion is clear. The ATO would consider all the factors and a ruling that addresses all the taxpayer circumstances may be needed too.

    Peter could also head to the GST decision making tool and make a serious error by answering NO to the first question - about enterprise.
     
  12. danielcannan

    danielcannan Active Member

    Joined:
    21st Feb, 2018
    Posts:
    37
    Location:
    Adelaide
    But why did he sell? Did his circumstances change or did he just change his mind?

    If it's a change of heart, it could be hard to argue that the intent was to rent out the second property. Why sell if nothing has changed?
     
  13. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    15,124
    Location:
    Sydney
    Thats fine. However if he sells to take profit he may have indicated a isolated profit making intention. This may mean one asset was held for revenue purposes and another his own home as a CGT asset. And a enterprise involving sale of new residential premises which would impact GST. The ATO also consider selling to reduce debt is also a profit taking act. So Peter sells the rental soon after moving in and then two months later also sells his own home. He may even find his own home is subject to tax and part of the enterprise. TD 92/135 could apply.

    Demonstrated intentions are better than spoken intentions and then contradiction

    However if Peter were to intend to rent and then he and his wife split and a sale is progressed on both far earlier than intended then it may be a mere realisation (CGT) with no evident enterprise. And no GST concerns.