Tax Tip 377: Tax Issues Temporarily Living in a Brand New Build

Discussion in 'Accounting & Tax' started by Terry_w, 8th Oct, 2021.

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  1. Terry_w

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

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    I encountered a client situation where they were planning to build a new house at the back of their existing property, move into that then knock down the front house and build this and move back into that – because it would be the bigger and better of the 2 houses.


    If they lived in the back house while building the front house later when they rented the back house out they would lose thousands in lost depreciation on plant and equipment (fixtures an fittings) because it would no longer be new when they first rent it.


    It would be convenient to move next door, but it might be more tax effective to rent elsewhere as this would allow for much higher tax savings


    Example

    Homer and Marg have a main residence with a very large back yard. They have approval to subdivide the land and build a new house at the back and a new house at the front. They want to do the build in stages for various reasons (build one house then later build the second house).

    They need to stay in the area for schooling.

    After the back house is built they move in. After a few months they contract with the builder to build the front house and built their dream home for $400,000.

    They move twice, but it is easy as they just carry their furniture and boxes from one house to the other.

    Because they have lived in the back house before once it is rented out they will not be able to claim depreciation on the items such as

    Carpets

    Curtains/blinds

    Hot water systems

    Air conditioners

    Etc

    All these items amount to about $80,000 and at a rough life of 6 years that would be $13,333 pear year in lost tax deductions for the first 6 years.

    This could cost them about $4,500 per year in real terms, after tax.



    Had they rented elsewhere and rented the back house out, they might have received $500 pw in rent, but had to pay $600 pw themselves, they would still have been ahead.


    @BMT Tax Depreciation – if a build cost was say $400,000 what would be the rough depreciation amounts for Div 40 plant and equipment amounts? I just made the figures above up.
     
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  2. Paul@PAS

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

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    If they were to sell the rear (new home) that they occupied it also may not access the main residence exemption for the period anyway. Many do the leap frog property thing when they dont seek tax advice early and then sell the former home and learn it was profit making issue, subject to GST and more and they think of CGT and exempt use. It a common belief that if you lived in it its tax free but is not the case for many new builds . But then TD 92/135 is considered. What is important to remember is CGT is "new tax law" and old tax law always taxed profit making from property before CGT laws were introduced. The CGT main residence can only apply if the new dwelling was a CGT asset...not one used for profit making. Even the first time.

    Typical 4 bed new build Div 40 may be $7000 in the initial year. Perhaps $30K++ over 8 years PLUS. Depends on the appliances etc. Garage motors, fans, flooring, window fittings and more. Allowing a typical marginal rate of 40% this is worth say $12K in cash refunds over the 8 years. That can be an appealing benefit to an investor.
     
  3. BMT Tax Depreciation

    BMT Tax Depreciation Chris Business Member

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    Speaking very roughly, on a standard residential build, plant and equipment is usually about 10-15% of the total contract price. So, you were a bit generous. First-year claim (and again, this is not an exact science) on plant and equipment might be about 20% of that, give or take.

    Is that what you were after?
     
    Last edited: 8th Oct, 2021
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  4. craigc

    craigc Well-Known Member

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    @Terry_w and @Paul@PAS ,

    What if in Terry’s example Homer & Marge are in a fast appreciating market (say 2021) and intending to hold L-T & rent out the back house.

    If they live in back house as genuine main residence for say 10 months whilst front house is built and then move back to the front house when complete and rent out back house. (As above example).

    As above, although they lose the depreciation claim of $30k (approx) and resulting $12k cash impact, could they however use the main residence exemption on the back house whilst living there as it has appreciated by say $100k over the 10 month build period?
    Then revalue cost base of back house when first rented out under s118-192 when moving into completed front house.

    If possible the main residence exemption could save say $100k in CGT (if holding L-Term and not selling, so not income, not GST) with CGT discount $50k in taxable income and $20 cash impact (depending on marginal tax rate).

    Net result $50k CGT saved v $30k depreciation lost (which note is also added back on later sale) so $20k taxable income saving and $8k after tax better off compared to renting out immediately.

    Although these results could only be determined after the fact it might still work out better.

    Or have I missed something else?

    Appreciate your work as always gents.
     
  5. Terry_w

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

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    Yes they could potentially choose one or other as the main residence when the first of them is sold.

    But then the other would be subject to CGT with the cost base going back to when the purchased the house many years prior to the builds.

    Of course if they never sell the second house the CGT would disappear at death as long as it was their main residence then.
     
  6. Paul@PAS

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

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    If a dwelling is a part of a enterprise it may not even be a cgt asset. No main residence can apply if its not a cgt asset.

    Then the new resi premises gst issue and lost gst credits and more.

    Blending a dev and home is a poor strategy unless the home is isolated and not a element of the enterprise. Then held longer term
     
  7. Hari Yellina

    Hari Yellina Well-Known Member

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    Hi Terry, can they rent it to themselves, if the property was bought on Trust?

    If they rent it to themselves using a property agent. what are the implications.
     
  8. Terry_w

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

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    It may be possible for the trustee to rent to a beneficiary, or even themselves. But lots of legal and tax implications such as can a trustee contract with itself, does the trust deed permit it, land tax, income tax, deductibility of interest etc etc.
     
  9. Hari Yellina

    Hari Yellina Well-Known Member

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    Thanks, Terry for your valuable advice.

    Yes, the trust deed was set up with the beneficiary renting it.

    But for someone, whose trust is already set up. can they make the alternations to the trust deed before moving it? adding the provisions for land tax, income tax, deductibility of interest etc.
     
  10. Terry_w

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

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    Whether a deed can be amended will depend on the wording of it and who has the power. But generally amending wouldn't change land tax, or income tax or deductibility of interest. These come from legislation.
     
  11. Paul@PAS

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

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    There should not be a need to amend a deed unless the trustee is the same humans as the tenants. The issue is a lease to the same legal persons if Mr & Mr are trustees and also leasing from the trustee. . If which case the amendmnet of the trustee may be needed if a lease is to be made. Depends on state and more. Wise to get legal advice.

    Then the terms of the lease are also critical. If rent is not market rates etc then tax concerns and trust concerns may arise. Tax issues arent generally affected by the deed but if the lease is deficient it could be seen as a issue.
     
  12. craigc

    craigc Well-Known Member

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    @Terry_w so the establish main residence for back house whilst front house is under construction and then reset cost base of back house to market value under s118-192 when first rented out couldn’t work?
    This would only apply when front house completes construction and Homer & Marge move into front house.

    As per above only if L-T hold and not for resale as Paul mentions.

    What have I missed?
    This is still hypothetical, I’m not doing this just always keen for more information & learnings.

    Thanks gents
     
  13. Terry_w

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

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    Both could be established as the main residence, one at a time, only one could be CGT free completely.

    If the main residence exemption is used on one then when the second is sold the main residence exemption cannot apply to that in full because of the overlap. Also the cost base won't be reset because the main residence exemption cannot apply back to purchase time - as this was used for the other property

    Tax Tip 43: Demolishing PPOR and Subdividing land and building 2 houses
     
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  14. Paul@PAS

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

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    I would suggest such startegies need tax advice. Merely recording the taxpayer intentions may assist. I will caution that if you build two and try to live in one and sell one, move etc it is a very high risk neither are a main residence. There is a tax strategy around duplexes (only) in this situation I dont mention on PC which can VASTLY assist tax savings in some instances. It can get MORE than one main residence exemption if the advice is followed.
     
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