TAX Q&A: Your tax questions answered

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Our tax experts are on hand to answer any tax queries you may have regarding your property investments and wealth creation strategies. Email editor@yipmag.com.au


Q: I purchased a house in February 2014 as a first home buyer and lived in it for roughly a year. I then refinanced a year after purchasing it as an investment property loan and moved back in with my parents. Now I'm planning on selling it and I would like to know if I'm able to apply for the CGT exemption. Thanks, Alston 

A: As a general rule, a dwelling is no longer your main residence once you stop living in it. However, in some cases you can choose to have a dwelling treated as your main residence for capital gains tax (CGT) purposes even though you no longer live in it.

Assuming that you purchased the property in your own name, you will be eligible for the CGT exemption because the property was initially used as your principal place of residence – provided you did not purchase or nominate any other property as your principal place of residence while you were living with your parents.

f you did not use your property to produce income while you were not living there (for example, you used it as a holiday home or you left it vacant), you can treat the property as your main residence for an indefinite period after you stopped living in it, provided it isn’t available for rent or advertised for rent.

If you used your property to produce income – for example, you rented it out or it was available for rent – you can choose to treat it as your main residence for up to six years after you stopped living in it. 

This is usually known as the ‘six-year rule’, and provided you move back 
into the property prior to the six years expiring, then you can start a new period of six years. 

There is no limit to how many times you can do this; however, please take into consideration the tax anti-avoidance provisions if your main purpose for doing this is to obtain a tax benefit. That is, you need to show that there is a genuine reason why you have moved out and back in again, such as your employer requesting that you live away from home to perform your occupational duties, or the need to care for family, your parents etc.

At this stage, either scenario will make you eligible for the main residence CGT exemption if you sell the property now.

“If you do not use your property to produce income … you can treat the property as your main residence for an indefinite period after you stop living in it” 

- Angelo Panagopoulos



Q: In June 2014 I purchased an apartment off the plan. I paid a 10% deposit, and 5% of that deposit was obtained via a loan from ANZ.

My question is: am I able to claim any interest and bank charges associated with that loan from the time the loan was taken out in June 2014, as it was intended for income- generating purposes?  

Thanks, Carol 

A: Interest expense is generally tax deductible to the extent that it is “incurred in the course of producing assessable income” or “necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income” and the interest expense is not capital, private, or domestic in nature. 

Therefore, assuming you are not carrying on a property leasing business, the answer to your question will ultimately depend on whether you have been “in the course of producing assessable income" since June 2014 when the loan was first drawn down. 

In this regard, a High Court case known as the Steele’s case provides the precedent legal principle that the interest incurred before any actual income is derived may still be treated as having been “incurred in the course of producing assessable income”.  

After the High Court handed down its decision on the Steele’s case, the ATO issued a taxation ruling, TR 2004/4, which states that interest incurred before the derivation of the relevant assessable income will be treated as “incurred in gaining or producing the assessable income” if: 

• the interest is not incurred before or as a prelude to the income-earning activities; 
• the interest is not private or domestic in nature;
• the period between when the interest is incurred and income is derived is not so long that the nexus between the interest and income has broken;
• the interest is incurred with the end goal of producing future income; and
• continuing efforts are undertaken to pursue that end.

For completeness, interest expense is generally not regarded to be capital in nature as it is incurred to secure the use of borrowed money during the term of a loan, rather than to secure an enduring advantage.  

An important issue to consider is whether the interest could be considered to be incurred “before or as a prelude to the income-earning activities”. The main difference between your situation and the Steele’s case is that the relevant interest expense was incurred on a loan after the acquisition of the property in the Steele’s case but before the acquisition of the property in your situation.  


"An important issue to consider is whether the interest could be considered to be incurred ‘before or as a prelude to the income-earning activities’"


Although it is not completely free from doubt, it is my view that this key difference should not change the analysis – provided that your purpose as an investor, at the time when the loan was drawn down, was always to use the borrowed funds to buy an apartment that would be used as an investment property from which you would derive rent once construction was completed. It may be reasonable to conclude that the drawdown of the loan and the purchase of the property coincided with the commencement of your income-earning activities. 

It would then follow that the interest incurred on the loan since the loan funds were drawn down would be tax deductible. 

However, my view is formulated based on the limited information you have provided regarding your specific circumstances. It is therefore advisable that you consult with your tax adviser before claiming a deduction for the interest – in particular, having regard to whether the interest was incurred before or as a prelude to income-earning activities.

The same rationale will apply to the bank charges, to the extent that the bank charges are not borrowing costs. Otherwise, the borrowing costs will need to be progressively claimed over the term of the loan or five years, whichever is shorter.

- Eddie Chung


Q: I have a question on capital gains in regard to a deceased estate, where one joint tenant has passed away and the other joint tenant is living in aged care.

The CGT question is in relation to a number of properties my father, my mother and I have interests in. My father passed away recently and I have been appointed the executor/beneficiary of his estate as per his will.

My late father and my mother are registered on title as joint tenants 
of the family home, but my mother had moved out of the home some four years ago into a high-care nursing home due to issues with Alzheimer’s/dementia.

My father continued to occupy the home until his recent sudden passing and my mother still has many of her possessions at the home and bills delivered there, despite being in the nursing home. 
 
The house was completed around 1980 (pre-CGT).

I am seeking to shortly acquire administrator responsibility for my mother through VCAT and hence have responsibility for managing her assets, including the family home, which my mother is almost certainly never going to return to. 

The house is currently vacant and I would like to know how the CGT would be determined if it was rented out for a period and then sold, or sold outright now? It should be noted that as I am named as executor/beneficiary in my mother’s will, I also have a vested interest ultimately in the best outcome.

My father, my mother and I also jointly own three separate investment properties that are on separate titles and were constructed around the year 2000. My understanding is that my mother has inherited my late father’s share in the properties under succession laws (even though my father named me as beneficiary in his will).

Are you able to advise what the longer-term CGT arrangements may be when I inherit the balance of the properties from my mother as specified in her will? 


Thanks and regards, Dusan

A: Thanks for your question in relation to this. You certainly have a few issues to consider in looking at your mother and father’s estate. You would need to go and seek tax advice in relation to the estate, but I have a few comments in relation to your questions.

Regarding the principal place of residence (PPOR), it appears from the information provided that your mother and father have lived in this residence until their death/until they had to go into a nursing home.  

As a general rule, pre-CGT property and your PPOR are passed on to beneficiaries at market value at the date of death. Those beneficiaries generally have two years to sell the property, and if the property is sold within these two years, then there will not be any CGT to pay from the date of death to the date of sale.  
After the two-year period, an uplift in the value of the property would attract CGT on the additional uplift.

You should also note that under the six-year absence rule your mother would have been able to rent out the PPOR from the time she entered the nursing home for a period of six years and could still claim the main residence exemption from CGT on the property.   

From the information supplied, your mother would have been able to rent the property out for the next two years without triggering any CGT on the property if the property was sold within that two-year period. 

Regarding your investment properties, this is a completely different story. 
As you can only have one PPOR, any investment properties are inherited by the beneficiary at the original cost base of the property when it was purchased.  

For example, with the three investment properties that were purchased, if the cost base of those properties was $600,000 and you subsequently sold those properties in a given tax year for $1.8m, you would have a $1.2m capital gain, of which 50% of this would be taxable. The result may be even worse than this, depending on how much depreciation was claimed. 

There are specific rulings on properties constructed after 1997 whereby the building depreciation is deducted from the cost base of the asset.

I suggest that you may want to consider the following from a tax point of view: 
1.      Stagger the sale of the properties over a number of years as any CGT is added on to your taxable income.
2.     You may simply want to rent these properties out as you will be able to claim normal deductions as a property investor and these could supply income for you into the future.
3.      If you want cash to pay off other debts, then the sale of the PPOR would be most beneficial from a tax point of view. 

As stated before, you will need to seek expert advice and incorporate this into a long-term financial plan to ensure that you are maximising a situation that could set you up for life. 

 - David Shaw



 

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