Tax Tip 209: How to Save CGT on Investment Property Part II – Planning ahead

Discussion in 'Accounting & Tax' started by Terry_w, 6th Jun, 2019.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    This is the second part of a thread I began in 2016:

    Tax Tip 119: How to Reduce CGT on Investment Property (Part I) Tax Tip 119: How to Reduce CGT on Investment Property (Part I)

    1. Claim the Main Residence Exemption

    Where you have previously lived in the property it may be possible to still claim the property as your main residence, even though you may have been absent and renting it out and keep it CGT free. This will be done by using the 6 year rule (s118-145). See my tax tip:

    Tax Tip 23: The 6 year Absent from Main Residence Rule


    Even where you have another main residence it can help with planning if you can live in your investment property (as your main residence) after it is first purchased. This way you will have a choice of which property to claim as your main residence on the sale of the 1st of them. It may then be possible to use the exemption on the property with the greatest gain.


    2. Claim a partial Main Residence Exemption

    Where you had not lived in the property before renting it out you may be able to claim a partial CGT exemption based on the number of days it was your main residence, i.e. a percentage of time that it was your main residence would reduce the CGT payable. This can also allow certain costs incurred while living in the property to be taken into account and reduce any CGT on the sale.


    3. Claim the main Residence exemption on another property

    Sometimes people will have a choice on which property to choose as their main residence. They may have had periods where they have lived in a second property, or their spouse has, and this property could also be classed as the main residence. Where the capital growth on the one being sold is less than the one being kept it might pay to not claim the main residence exemption. 3rd element cost base expenses while living there may also bring down any capital gain to be very low.

    4. Ownership Choice

    Ownership needs to be decided upfront when the property is purchased but planning ahead can help reducing future tax on the eventual sale of the property.

    Utilising a discretionary trust can give flexibility in the distribution of income, including Capital Gains, amounts a large number of potential beneficiaries. This flexibility can help divert the capital gains to other family members who may have capital losses to offset the gains.

    Superfunds are concessional taxed entities so a property that is owned by a superfund may result in the fund incurring just 15% CGT or 10% CGT for property held longer than 12 months. When a pension is being drawn from the fund the tax rate can be reduced to nil.


    Which spouse owns the property can also help with CGT. Sale of the property in the year that the owner is not working can help with the savings.


    I also favour owning in just 1 name over joint ownership as this will result in greater flexibility in saving CGT. See my reasoning on why a property should not be purchased in 2 names here

    Strategy: Buying Investment Properties in 1 name only





    However, buying in joint names 50/50 can actually result in savings as when the property is sold any capital gains would be split according to ownership percentage and this would result in overall tax savings.



    5. Pre CGT property

    Property purchased before 20 Sept 1985 will always be free from CGT until the owner dies. Even if rented out the property will be exempt (in most cases). Where a person owns pre and post CGT property It may work out better (from a tax point of view) to live in the post CGT property and have this CGT exempt and to rent the pre CGT property and have this also exempt.


    6. Revalue before moving out

    Where you move out of a property that was formerly the main residence, and assuming you will not use the 6 year rule, then the cost base for CGT will be the value as at the date the property was first income producing.

    The ATO may accept a valuation to determine the market value. But keep in mind that valuations can vary between valuers depending what comparable sales are used. A valuation which is $20,000 lower could result in a potential tax saving of $5000

    See

    Tax Tip 173: Strategy – Don’t rely of a lender’s valuation for CGT Purposes Tax Tip 173: Strategy – Don’t rely of a lender’s valuation for CGT Purposes


    7. Operating a Business at home

    When operating a business at home this and mean CGT is payable on the home. The rule for this is if the interest is claimable then the full main residence CGT won’t be available. So if you are going to run a business from home make sure the owner of the home is not the one running the business. If this is the case then no interest would be claimable.

    See

    Tax Tip 91: A Non-owner running a business at home Tax Tip 91: A Non-owner running a business at home


    8. Construction on vacant land

    Where you are building your main residence there are rules about how soon you must live in the property and for how long otherwise it won’t be possible to claim the property as the main residence from the date the land was purchased.

    See

    Tax Tip 99: Vacant Land and the CGT Exemption Tax Tip 99: Vacant Land and the CGT Exemption


    9. Later in life move into your property with the biggest gain

    Sell the main residence and move into the investment property with the biggest capital gains. The sale of the main residence could be tax free while so could the one you move into if it is your main residence at the date of your death.

    10. Special Disability Trusts

    If you have a related family member who has a disability it may be worthwhile considering a transferring the property to a SDT as this can be done without triggering CGT. Naturally there are lots of issues and conditions to consider.


    11. Claim the main residence exemption on 2 properties

    It can be possible to claim the main residence on 2 neighbouring properties where both are being used as one main residence. This is the case even though they may be on separate titles.


    12. Don’t have flat mates or Airbnb your property

    If you have flatmates you might be able to claim a portion of the expenses on your tax. However, these savings will be minimal compared to the eventual capital gains tax that you might end up paying.

    Airbnbing your property for a weekend could also result in a huge CGT bill when you sell as well, so take care. This because the cost base is reset to market value when the property is rented out.


    13. Don’t move out when there is a slump

    You don’t want to have to value you house for CGT when the market has crashed as this could lead to a capital gains tax bill when you sell at a loss.
     
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  2. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    One of the most effective methods of reducing CGT is having good records. These can be used later to get personal tax advice.

    eg Peter & Lois move into their own home and ignore CGT. Peter uses the home as a place of business around 4 years into the ownership. He is a mortgage broker who works out of home. Then a year later they make it an IP and rent elsewhere. And keep it for 7 or more years. They will have a CGT issue and WILL likely overpay tax.

    What they need is a CGT records from day one for every property they own. That records dates, key costs and most importantly dates of specific events AND 3rd element costs. These are non-deductible ownership costs. They wont always be permitted but years later when it is realised that the private costs incurred by Peter & Lois in the first 5 years could have been factoring oito the CGT calc eg
    - Mortgage interest, rates and private improvements in the first 5 years less the amount actually claimed in any tax returns;
    - Key costs incl original costs such as duty, legals etc
    - If applicable (not in this case) date and market value at the date the property first produced rental income
    and so on

    We offer a CGT record keeping tool for this purpose. You just never know when you may need to know this information and years later it may be dificult to identify and access the information.
     

    Attached Files:

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  3. craigc

    craigc Well-Known Member

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    Great tips again thanks Terry,

    One minor thing - I think this is back the front,
    A $20,000 lower valuation would result in a lower cost base and a $5,000 higher CGT bill not a saving.
    Or in reverse a $20k higher valuation would result in the $5k CGT saving.

    Keep up the great tips!

    Cheers

     
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  4. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    As Craigc's eagle eye pointed out, I got this around the wrong way.

    A higher valuation when moving out would result in a lower CGT bill in the future. This should read:
    6. Revalue before moving out

    Where you move out of a property that was formerly the main residence, and assuming you will not use the 6 year rule, then the cost base for CGT will be the value as at the date the property was first income producing.

    The ATO may accept a valuation to determine the market value. But keep in mind that valuations can vary between valuers depending what comparable sales are used. A valuation which is $20,000 higher could result in a potential tax saving of $5000

    See

    Tax Tip 173: Strategy – Don’t rely of a lender’s valuation for CGT Purposes Tax Tip 173: Strategy – Don’t rely of a lender’s valuation for CGT Purposes
     
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  5. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    One of the traps to s119-192 market valuations is evident in a common situation.

    Fred and Mary buy a house to live in. Three weeks later circumstances mean they must rent the property and move interstate. s118-192 resets the costbase to its market value.

    What about all the on costs like legals and duty ??? Hmm they are now not relevant. Fred and Mary will be adversely affected unless they can use a CGT exemption such as the former main residence exemption etc So the choice of buying in their new city may be a factor if they seek to use that property as the main residence. Their cost base now excludes what can often be $25-$40K of costs
     
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  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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  7. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    But there can be marginal benefits of claiming a tax loss which tends to occur with taxpayers who have a negative taxable income rather than a small income under the threshold. . This will accumulate and can be used to reduce the discounted taxable gain in the future. Its very common with people who are non-resident with IP income or a non-working spouse. In these cases it may pay to maximise the tax loss v's reducing the gain PRIOR to discount (if any). At its worst case the value of the tax loss and the CGT amount would be no different. ie High tax loss = reduced gain.

    The new 6 year absence rule for non-residents will impact this
     
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  8. thesuperman

    thesuperman Well-Known Member

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    Homer & Marge purchase a block of land in 1980 and build a house on it which immediately becomes their PPOR. Since it's a big block they decide to build another house on the block 10 years later in 1990. They decide to rent it out as soon as it's built. Today Homer & Marge gets a generous offer from Mr. Burns to purchase their house so they decide to sell. Will their property still be considered pre-CGT property therefore no CGT due since it's all one block which was purchased pre-CGT?

    Next door to Homer is Ned & Maude. They also has a pre-CGT property which is also their PPOR. They both operate a home-based business selling moustache styling products. They claim interest payments on their tax returns. Mr. Burns also offers to buy their property and they decide to sell. Would it still be tax-free with no CGT due or will it be due as per the above No.7 point?
     
  9. thesuperman

    thesuperman Well-Known Member

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    Homer & Marge purchase an investment property with two houses on one title. They rent it out immediately. 40 years later Homer doesn't think he has many years left so Homer & Marge move into that property with two houses on it with Homer living in one house and Marge in the other. Homer passes away. Title passes to Marge (either as Joint Tenants or TIC with a will leaving it all to Marge) so she now owns 100%. A year later Marge passes away and all assets are left to Bart.

    In this scenario there would be no CGT due on either Homer's death or Marge's death because they can claim the main residence exemption? Do both of them need to move into the investment property before Homer passes away?
     
    Last edited: 13th Jan, 2020
  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    No.

    No.
     
  11. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    Assuming Bart sells it (within 2 years and doesn't use it to produce income etc) and it was the main residence of the deceased as of their death it would be CGT free
     
  12. thesuperman

    thesuperman Well-Known Member

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    What happens if Bart decides to keep it after 2 years or decides to rent it out? Will the CGT clock reset on the date of Marge's death?

    Eg. Property worth $1mil at Marge's death. Bart decides to keeps the property and rents it out. CGT clock resets and the cost base will be $1mil if Bart sells many years later in the future?
     
  13. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    cost base is reset to market value at the death date. Bart might even use the 6 year rule.
     
  14. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    There is a special CGT rule which considers a separate asset exists if it is added to the former asset and it exceeds a cost threshold. If the addition is minor it would be added to the costbase of the pre-CGT asset and disregarded. If it exceeds the threshold for additions it is classified as a different asset and on sale a reasonable apportionment must occur.

    This can also be complicated if a improvement is added to a pre-CGT asset and that improvemnet is used to produce income. The asset may be taxable as a separate asset without any threshold. This is common for a GF.

    Nanna owns a old home since 1955. Her grandson Peter suggests in JUly 2018 that she put a GF in the large yard and rent this for extra income. The GF cost $100K which is less than the improvement threshold noted in TD 2018/8. Nanna sells the home a year later to go to aged care. Her tax adviser then explains the GF means a CGT issue occurs.

    Capital improvements and separate assets

    There are many ways to impact a pre-CGT asset. eg demolition and reconstruction of a dwelling, relocation of dwelling etc.
     
  15. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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  16. Pev

    Pev Member

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    Terry- I've searched for a thread relevant to the following example but don't think it has been addressed so I'll post it here seeing as it relates to CGT.

    If one were to purchase a property that has an existing old property on it and permits available for 3 new townhouses that are then constructed a few years later, is there a way to satisfy the main residence exemption rule at all for any of the new townhouses? Say at the completion of one of the townhouses you moved into it and lived there for a period of time (6-12 months). If you then sold that townhouse, would it be exempt from CGT via the main residence rule?

    Also would there be any benefit in living in the old property from a future CGT POV (when the townhouses are sold) until it is demolished for the construction? Or would it be irrelevant in the ATO's eyes?
     
  17. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    I wouldnt be wise blending the MRE and a development. They are generally exclusive of each other. There is a tax ruling on that issue. Personal tax advice would be wise.

    Your enterprise may include all townhouses.

    Even if you did move into the old house the MRE terminates when you vacate and cant continue. You cant reside on land. You cant be absent when a dwelling is demolished. You cant have a MRE and a development for profit making. Sale wouldnt be a CGT asset. Hence not exempt. + GST issues. This of course also impacts land tax.
     
    Last edited: 21st Jan, 2020
  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    Assuming this is on capital account - yes it is possible.

    I have written about something similar here:
    Tax Tip 43: Demolishing PPOR and Subdividing land and building 2 houses Tax Tip 43: Demolishing PPOR and Subdividing land and building 2 houses
     
  19. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    But the question doesnt seem to intend capital account. Thats the issue needing advice.
     
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  20. Pev

    Pev Member

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    What is meant by the term capital account? A quick google search brings up pages related to international macroeconomics o_O