Tax Tip 244: A valuation is not needed if Moving into an Investment property

Discussion in 'Accounting & Tax' started by Terry_w, 21st Sep, 2019.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    When a person moves into an investment property there is no point in getting a valuation done for CGT reasons as it cannot be used. I have seen many people recommend getting a valuation done but this will be a waste of money.


    The CGT will be apportioned based on time if a person moves into a rental property and later sells that property.


    Example

    Homer sells his main residence and moves into a rental property he has owned for 5 years. The property was purchased for $100,000 and it is now worth $500,000.

    Homer’s drinking buddy Barney tells Homer he must order a valuation. Homer spends $400 getting one done which shows the property worth $500,000.

    5 years later Homer sells the property for $500,000. The market was flat for the past 5 years so no growth.

    Homer thinks great no profit made.

    But he is wrong.

    The capital gain is $400,000. Proceeds of sale less cost base. He can also include other cost base expenses to reduce this, then it will be apportioned. Since the property was a rental for half the time there will be half of this gain subject to CGT – after the 50% CGT discount is applied too as the property was held longer than 12 months.


    See section 118-185 ITAA97.

    The formula is provided in subsection 118-185(2) of the ITAA 1997 and is as follows:

    CG or CL amount x (Non-main residence days/days in your ownership period)

    where:

    "CG or CL amount" is the * capital gain or * capital loss you would have made from the * CGT event apart from this Subdivision.

    "non-main residence days" is the number of days in your * ownership period when the * dwelling was not your main residence.

    INCOME TAX ASSESSMENT ACT 1997 - SECT 118.185 Partial exemption where dwelling was your main residence during part only of ownership period
     
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  2. Phar Lap

    Phar Lap Well-Known Member

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    so if Homers house did achieve cap gains after he moved in?
    Still apportioned over days held in total?
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Yes, even if it dropped in value too.
     
  4. hieund85

    hieund85 Well-Known Member

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    Thanks Terry. And I would assume it applies to the other way around too (i.e., turning a PPOR to an IP), isn't it?
     
  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    No, that is different. A valuation is needed if the main residence becomes an investment property as s118-192 ITAA97 applies in this case.
     
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  6. hieund85

    hieund85 Well-Known Member

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    Thanks @Terry_w .
     
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  7. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    There are a few instances when a valuation is required or important

    1. Apportioning two different uses for the same property
    2. When a home that has solely been used privately since acquisition first is used to produce income (s118-192)
    3. When a person dies, for estate purposes and for tax purposes.
    4. When a person owns FOREIGN property and commences Australian tax residency.
    5. When ownership % changes and the parties are not arms length. The valuation value is used for CGT and duty rather than what the parties agree is the consideration.
    6. Where the asset is a SMSF investment. The market value is required to be the reported asset value in the financial & member reports
    7. When a property is owned by a unit trust and a change of unitholders occurs. The ATO expect that market valuation is the basis for the value shift or redemption etc.
    8. In some cases when a property ceases to be a CGT asset and is first held as trading stock the owner may or not be able to elect to use market value v the costbase.
     
  8. FredBear

    FredBear Well-Known Member

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    What happens after this point? For example if the PPOR is rented for 8 years and then sold, and the first 6 years use the absence rule, is the CGT calculated on 25% of the difference between the sale price and the valuation, or should the CGT be calculated on another valuation done at the end of the 6 years and the sale price?
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  10. FredBear

    FredBear Well-Known Member

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    Thanks Terry - I did say PPOR so it was implied that the move in had occurred - in this example it doesn't matter if the home has been occupied as PPOR for 2 years or 20 years before it is rented out the first time.

    Let me re-phrase the question like this:
    PPOR is first rented out after X years of ownership/occupancy. The valuation on this date is V1.
    After 6 years, the value is V2.
    After another 2 years, 8 years after first renting out the home, the value is V3 and the home is sold.
    Capital gain for the first 6 years (V2-V1) is not taxable as the 6 year exemption rule is used.

    The CGT could be calculated two ways:
    1. Proportioned by time (days exceeding 6 year exemption/total days rented):
    Taxable capital gain = (V3-V1)*.25
    The assumption is that there was a straight line increase in value from V1 to V3. The valuation V2 is not relevant.
    2. Actual increase in value during the last two years:
    Taxable capital gain = V3-V2. The valuation V1 is not relevant.

    The question is which is the correct method to calculate the CGT, or can you choose the method?
    Thanks!
     
  11. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Cost base is reset to market value at first rented, unless the 6 year rule used.

    If using the 6 year rule and the absence is longer than 6 years then I explained this in tax tip 109.

    Your 1 might be correct if I have understood your correctly
     
  12. inbaaa

    inbaaa Active Member

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    thanks for the valuable tip, Terry. When a PPOR turns into an IP, who can officially do a property valuation? I heard an formal letter from a real estate agent stating the property's value on that particular date would suffice. Is that correct? How about a Bank's desktop valuation report? Any other avenues? thanks!
     
  13. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  14. Waterboy

    Waterboy Well-Known Member

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    how about if you're moving out of PPOR to rent it out, do you need valuation for the old place or is it same time-based pro-rata capital gain allocation?
     
  15. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    if you move out of a main residence that was CGT exempt and it first becomes income producing then you need a valuation at that point

    Tax Tip 321: CGT Differences between Renting a Main Residence and Moving into an IP Tax Tip 321: CGT Differences between Renting a Main Residence and Moving into an IP
     
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  16. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    ...and when you move back out no valuation. Pro-rata is based on the number of taxable days v total ownership days after the s118.192 valuation date.
    BUT its important that the taxpayer realise there are two possible benefits provided they dont move into a property they or spouse own
    1. Can the absence rule extent the CGT exemption by up to 6 more years ?
    and regardless of where they move .....
    2. Third element costs (ownership costs while it is you occupy home aftre the s118.192 date) can add to the costbase so the profit is reduced BEFORE it is apportioned.
     
  17. Roosterman

    Roosterman Well-Known Member

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    I bought a PPOR in 2014 and it became an IP in 2016. If I did not get a valuation at the time I moved out in 2016, how do I work out the value for CGT purposes when it became an IP?
     
  18. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    You could seek a reg valuer who has suitable data and skills to backdate the valuation. Its common. There can be issues that may affect a costbase reset. eg You are spouse each have a home, they lived wih you while in 2014-16 etc. Then perhaps some tax issues to consider if the absence rule allows the period 2016-2022 as exempt also v another property.
    The major issue is clarity on dates.
     
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  19. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    note that some people won’t need a valuation if absent for less than 6 years (not all cases though) but you will because it has been 7 years since you moved out
     
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  20. craigc

    craigc Well-Known Member

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    Hi @Paul@PAS - I understood the taxpayer can still use the choice of either claiming 6 year absence rule or claiming the other property moved into that they or spouse own as their MR (but not both of course).

    Can you explain why this is not the case as per your comment above please?

    Calculations to determine which is more favourable would need to be done at time of first sale.

    Thanks