Tax Tip 27: Borrowing to knock down PPOR and build duplex and Rent one

You should seek specific advice - it depends.

 

Living in a property isnt sufficient on its own to make it a main residence according to TD 92/135.

That determination addresses the question of IF a property that is developed for profit can also be a main residence. In that ruling it uses a vague example of a tradesman which may be a piece of the puzzle some taxpayers mistake as an indication of a situation that solely applies to a tradesperson. However the determination discusses a profit making intention from EITHER isolated transaction or a enterprise that occurs in conjunction with use of the property as a residence for the taxpayer and family.

A builder constructs a spec home in which he and his family reside while construction proceeds on another spec home

The key issue is that where a taxpayer constructs with an intention of selling the property to realise a profit then occupancy does not trigger a capital asset. Hence the property is always taken to be held on revenue account and a main residence exemption cannot apply as it exempts a CGT profit from being taxed.

There can be circumstances which differ from this and do permit a CGT event later. However, I would consider one of the essential elements that should be evident include NO intention by the taxpayer to sell the property at the time of construction. To satisfy this its generally needed that the taxpayer has no intent to move from the property for any purpose for a reasonable period of time. Co-incidentally arguing after 6 months that you want to sell and live in rented accomodation etc and repeat the process probably wouldnt wash. However occupancy for four year and then moving interstate to follow a work opportunity poses a different set of facts.

 

Example

James has just bought a block of land by borrowing 100% of its value of $500,000. He wants to construct a duplex and live in one and rent the other out. Construction costs are $500,000 and he has $500,000 cash so his plan was to just use the cash for the deductions.

If he had done this he would have $500,000 debt at the end but 50% of the debt would relate to the investment portion and 50% to the owner occupied portion. He will have $250,000 of non-deductible debt.



Instead James decides to borrow $500,000 for the construction component and to keep the $500,000 cash in an offset account attached to the loan – which would be $1mil.

After completion of the project the loans are split in proportion to the property values – in this case the properties are of the same value so James ends up with 2 loans of $500,000 each. He then moves the offset account over to the loan associated with the property he is living in. $500,000 loan with $500,000 offset means no interest is payable and the loan could be paid off at any stage. The investment loan will be $500,000 and all of the interest would be deductible.



James has just increased his deductions by $12,500 per year ($250,000 x 5% interest rate). This would amount to $5,875 cash in his pocket each year (if on the top tax rate).

 

Hi Terry

I have been reading this thread and they have been very helpful. I am in a similar situation (maybe more simple) that my parents own a house as their primary residence for the past 15 years, wishes to knock down and build duplex with me. I also lived in that house until 6 years ago and my sister is still living in there. Our plan is to build a duplex, subdivide then parents live in one and my family live on the other.

The value of the house (mainly the land) has increased quite significantly over that period and now my parents are concerned about the CGT. We found that if my parents keep both duplex then CGT doesn't incur however their pension is impacted due to the asset test.

What would be the best way to minimise the tax? Any help is much appreciated!

 

They should seek legal advice. This comes up a lot these days and there is a lot to consider

 

One strategy that is subject to some IFs (italics) is this.....

Parent sell the duplex that they have lived in. Its CGT exempt
Then...Move into the rental portion and remain there.
If they each die while living there it loses the original CGT that has accrued on a time pro-rata basis from the period it was rented up the date they moved in.

Then the whole building has become 100% CGT free. Legally

 

Only if they hold it in the corr cgt ownership structure will cgt be reset. But this will cause loss of the pension

 

Hi Terry, thank you for the advices. Are you able to advise us further please? Not sure where to get your contact/email..

 

No, I am fully booked for months at the moment.