Tax Tip 157: Difference on being taxed Capital v Revenue Account

The Difference between being taxed on capital account compared to investment account



We have seen here that there are 2 ways that the profit on the sale of a property can broadly be taxed – as either revenue or as capital gains. In most cases the taxpayer would be better off if they are being taxed as a capital gain because of the 50% discount.



Let’s look at an example on what the potential tax difference could be.



Scott buys a $500,000 property on 1 July. He spends $100,000 to do it up and then resells the property on 2 July the next year for $800,000.



That is a profit of $800,000 - $500,000 - $100,000 = $200,000



If Scott is a resident individual on the top marginal tax rate he would pay tax as follows

a) If taxed as Capital Gains

b) If taxed as Revenue



a) Capital Account

Scott assumes he is taxed on capital account so he sells and records the profits in his tax return as capital gains.

With the 50% CGT discount Scott would be taxed on $100,000 of that gain and would therefore pay around $47,000 in tax. This would mean a profit of $153,000.



Not bad for a year’s ‘work’.



But after a year the ATO audit Scott and determine that the profit should have been taxed on revenue account as an ‘isolated transaction’:

b) Revenue account

There would be no CGT discount available to Scott. He would be taxed on $200,000 at the top marginal tax rate of 47% = $94,000 (plus penalties and interest for getting it wrong). His profit drops to $106,000



It could be even worse if Scott had a carried forward capital loss. He may have paid no tax at all on capital account as the loss could have been used to offset the gain.



Moral of the story: Don’t assume your sale will be taxed as capital gains. Get taxation advice before selling as the outcome may cause you to not sell.



Note that transaction and holding costs have been ignored in the above.

 

Also timing issues can be affected.

CGT = Generally based on contract dates
Revenue = Generally based on settlement date

This can affect not just income tax but also GST where it is relevant

 

Thats a good point Terry. I often encounter people who seek sell dev property and tell me they made $X. I check the calcs when doing GST or tax and its often far far less than they think. They then question why they bothered.

I am always amazed that they undertake a (multi) million dollar investment with no idea if its profitable, have no plan and no budget. No better example IMO of the old adage "having no plan is a plan to fail"

The developer toolkit we provide helps alleviate that so a plan can be developed before purchase. Profit can be planned by the client rather than taxes becoming an after thought. I have many clients who do devs who properly plan and diligently treat their devs as a profit making venture and they can make serious profits...Planned profits.

And a good plan also plans how to pay less tax on the planned profit too
And contains a contingency element

 

What is an isolated transaction?
Legal database - View: Rulings: TR 92/3

 

A brief reading of this would seem to deem any profit from property investment activity to be “income” due to the intention to make a profit?

 

did you know you can also have a section 6-5 income and a capital gain. the capital gain will be reduced by the section 6-5 but it can leave a resulting capital gain and income result.

section 118-20 reduces the capital gain by any section 6-5 income before a net capital gain is calculated

 

And if there are tax credits that can be important. You can have a trust loss in one category (ie Non PP) and yet have net trust income that remains positive eg cap gains etc.
It does my head in and I must say the software avoids a brain explosion.
I wouldnt even attempt to do a trust tax return without software. And I think I know what I'm doing

 

Often yes but not always. Owning property to produce rental income would be income and a resulting capital gain in many instances. But acquiring property to develop, reno and then sell for a (hopefully) higher price even if there is rental income may b revenue activities. As an example I always fall back to the example of land. Reselling land is almost impossible to a be a capital gain unless its a mere realisation (ie a couple who split up). Doing things to the land and reselling is an enterprise....Profit doesnt have to mean what we usually think of as profit either. If you subdivide and pay down a loan and make little money but it financially benefits by reducing a debt - That can be profiting.

Its also possible to have a little of both even. I wouldnt recommend it but it does happen