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CGT ISSUES WHEN BUYING AND SELLING PROPERTIES AS A BUSINESS
Question: I would like to get into the business of renovating properties (buying and selling properties within a three-month period). I understand that I cannot continue to purchase under my PPOR [principal place of residence] as it would then be classed as a business. In addition, I will be ineligible to receive the 50% discount for CGT as the property will not be held over one year. Is there an alternative way, ie putting the property into a trust structure or under a company title, which will enable me to offset some of the tax?
There are three matters to consider here. The first is the principal place of residence. Generally, there are no income tax, capital gains tax or GST implications if you build or renovate your own home, provided it is your main residence and you undertake the work for private purposes. However, as you correctly state, you are likely to be entering into a profit-making activity if you acquire a property with the intention of renovating and selling it at a profit, and this may affect your tax obligations and entitlements.
The second is the eligibility for the 50% discount. It should be noted that generally when a property is purchased with the primary intention of renovating and selling, this does not fall under the capital gains regime. This type of activity is taxed as ordinary income. As you have stated, it is true that in many cases the property will be purchased, renovated and sold within the year and the discussion regarding capital gains may be somewhat academic, as a property purchased and sold within a year does not qualify for the 50% capital gains exemption. However, if the renovation and sale take longer than a year, this type of activity may not qualify for the capital gains exemption.
Thirdly, there may be some advantages to using a company or trust for this type of activity. The company is taxed at 30% and, depending on the personal tax rates of the shareholders, the company structure may offer a lower tax rate. The trust offers the advantage of profit splitting, that is an ability to distribute profits to the beneficiaries who may be on lower tax rates. A disadvantage of these structures is that, if the decision is to keep a property rather than sell it, the capital gain and/or negative gearing may be compromised. Another consideration is that both of these structures may offer a level of asset protection and should be considered at the time of signing the contract for the purchase of the property.
CGT ISSUES WHEN TURNING A HOME INTO AN INVESTMENT
I am planning to move to another house after 15 years in the present one. I want to let this house for the next three to four years. How will the capital gains tax be calculated? Will I have to pay for all the increase in value for the last 15 years?
Answer: On first being acquired, a property can be established as either a main residence or a rental investment. The nature of first usage of the property will dictate how the CGT is calculated on sale at a profit. Whenever a property is occupied as a main residence, it will be exempt from CGT for that period of time. The legislation allows only one main residence for each single person or family.
When a property is first established as a main residence on acquisition and later rented out, it can be exempt from CGT if sold within the next six years from the date it was first rented, but only if no other property is nominated as a main residence. An example of this is when people are located to other states or overseas.
If another property is nominated as the main residence, then any gain on the sale of the first property will be subject to CGT. Examples include when people move to a new property and rent out the old property after receiving an inheritance or having paid out the loan, or their kids have grown up and they need somewhere larger to live. In its simplest form, CGT is basically calculated as the difference between the net selling price and the cost base. The cost base will be the market value of the property when it changed its character from main residence to rental property. So any growth while it was a main residence is not taxed.
By contrast, when a property is first established as a rental investment and then changes its character to a main residence, its cost base will include the original purchase price, stamp duty, legal fees, building inspection fees, etc. The capital gain will be calculated as the difference between the net selling price and the original cost incurred. The taxable portion of the capital gain will then be apportioned on the basis of time occupied as a rental and time occupied as a main residence.
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