​​​​​​​Tax Q&A: Questions on Selling a Property and More

By Sarah Megginson | 11 May 2017
Our tax experts are on hand to answer any tax queries you may have regarding your property investments and wealth creation strategies.
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Q: I have a property I bought and moved into as my principal residence in 2001. I then rented it out from 2002 (and had it valued at that point) and went to live with my parents before moving overseas in 2004. 

I rented my home in the UK until 2007, then I purchased a residential property to live in there (in the UK). I lived in it until 2015. 

In 2016, I moved back to Australia and rented a new place while I continued to rent out my original property – the one bought in 2001. 

I am now selling and trying to work out if I am entitled to use the six-year rule regarding CGT, and for what period of time? 

Regards, JW

A: Yes, you should be able to access the six-year absence rule in Section 118-145 of the Income Tax Assessment Act 1997 if the property was established as your main residence before you moved out and started renting it in 2002.  

If the property was rented from 2002 and continues to be rented until it is sold, then you can treat it as your main residence for Australian capital gains tax purposes for:

•    the period from the time the property was bought until you moved out of it in 2002 (assuming that you established the property as your main residence as soon as was practicable after acquiring it); and
•    the first six years that the property was being used to earn rental income 

If you elect to treat the original property as your main residence for the whole period of the fi rst six years that it was used to derive rent, then this will potentially expose your UK property to capital gains tax for some of the overlapping ownership period (although the capital gain or loss on the UK property would generally only take into account the movement in the value of the property from the time you became a resident of Australia again). 

Alternatively, you could choose to treat the original property as your main residence up until the time you bought the UK property so that you can potentially preserve a full exemption for the UK property when it is sold (subject to the UK property actually meeting the other basic conditions to qualify for a full exemption).

You need to obtain a valuation at the date that the property first earned rental income, regardless of whether you apply the six-year absence rule. 

“You need to obtain a valuation at the date that the property first earned rental income, regardless of whether you apply the six-year absence rule”

You have now exceeded the six-year period, whether or not you choose to use the full six years. Once the six-year period is exceeded, you are liable for capital gains tax on a portion of the uplift from the property’s value at the date fi rst rented to the amount that you sell it for. This fi gure is calculated based on the number of days the property is treated as your main residence versus the total number of days you have held it overall.

Q: I’m looking at buying a property in NSW and setting it up, under a family trust, as an investment without a mortgage. My questions are:

•    Are you required to pay stamp duty under a family trust?
•    Is there a tax liability enforced on trust properties?
•    When property is sold, is there capital tains tax enforced on trust properties?
•    With no existing mortgage on the proposed purchase, can you access the rental income within the family trust?

Thank you, Stephen

A: A trust is not a separate legal entity and the trustee is responsible for most legal obligations pertaining to a trust property. However, for income tax purposes, the trust is treated as a separate entity.

To address your specific queries: 

1.     Where the purchaser of a property is acting in the capacity as trustee of a trust, the trustee is generally responsible for stamp duty on the purchase of a property, regardless of whether the trustee is an individual or a company. It is advisable to have documentation that shows that the trustee is acquiring the property in the capacity of trustee so that it can be proved that it is trust property. Any stamp duty paid on acquisition of the property will be included in the cost base of the property for future capital gains tax (CGT) purposes.

2.     Although a trust is not a distinct taxpayer from the trustee, the trustee is required to account for any income and/or capital gain it derives in relation to the trust property in a separate trust tax return every year. However, a trustee usually does not pay tax on the trust income or capital gains except under limited circumstances. Rather, where the beneficiaries of the trust are made entitled to the income and/or capital gains of the trust, the taxable income of the trust is generally taxed in the hands of the beneficiaries by including their share of the trust’s taxable income and/or capital gains in their own taxable income and paying tax, if any, in their own right. There are complex rules for determining the income and capital gains of the trust and the beneficiaries’ share of the taxable income and capital gains, so it is highly recommended that professional advice be obtained. 

An exception under which the trustee is liable for tax on behalf of a benefi ciary is where the trustee has not made the benefi ciaries of the trust entitled to the income and/or capital gains by the end of the income year. This is best avoided as the tax rate under these circumstances is usually the highest marginal tax rate. 

Another exception is where a beneficiary to whom a trust distribution is made is under a ‘legal disability’ (eg the beneficiary is under 18 years old) or is a non-resident. The trustee will generally be required to pay tax on behalf of the beneficiary in these cases. However, the tax liability is usually calculated at or close to the relevant beneficiary’s own margin tax rates.
An important point to note is that if the trustee has made a ‘family trust election’ under the ‘trust loss provisions’ and a distribution is made by the trustee to a beneficiary who is not a ‘member of the family group’ of the ‘test individual’ of the trust, the trustee will be liable to pay a family trust distribution tax. These are complex provisions and professional advice is highly recommended.

3.     As mentioned above, CGT has the potential to apply to all CGT assets owned by a trust, including real property. The trustee will need to calculate and include the net capital gain on the sale of the property in the trust’s taxable income, which will be treated in the manner described above.

4.     The cash representing the net rental income of the trust can only be accessed in accordance with the trustee’s powers and responsibilities under the trust deed and under trust law. The issue is how the cash withdrawal is characterised. Assuming that you are only trying to access the cash as a family, you can simply withdraw the cash as a loan owed to the trust during the year, which may be offset by any monies the trust already owes you and/or the trust distributions made by the trust to your family by the end of that year. 

Assuming that the trust is not a fixed trust (ie it is a discretionary trust), the fact that your cash withdrawals are more or less than the taxable income distributed by the trust to the relevant beneficiary will not generally give rise to any taxation consequences. More often than not, the amount of cash withdrawn may be higher than the trust distribution due to non-cash items (eg capital works and depreciation deductions) that would reduce the taxable income of the trust.  

“Trusts have been a thorn in the tax office’s side for some time because of the potential tax benefits they can provide”

However, if a beneficiary ends up owing monies to the trust, further analysis should be undertaken to ensure that all of the interest expense attributable to any loan drawn down to purchase the property will remain tax deductible (which should not affect you as you are buying the property without any mortgage). 

In conclusion, you should bear in mind that trusts have been a thorn in the tax office’s side for some time because of the potential tax benefits they can provide. This has led to the introduction of complex legislation to address the perceived loopholes. To ensure you are complying with all these rules, getting professional advice is strongly recommended.

Q: Can you help me with the tax laws in the following scenario, regarding passing on real estate assets and tax liabilities?

Person A purchased real estate (land + house) in 1981 and used it as an investment property.
Person A died in 1998, leaving the investment property in her will to her sister, Person B, who continued using it as an investment property.
Person B died in 2015, leaving the investment property in her will to her son, Person C, who continued using it as an investment property.
Person C had the property valued upon Person B’s death.
Person C then sold the property in 2016, 12 months after acquiring ownership of it.

How is capital gains tax viewed or calculated in this scenario? 
Thank you, Geoff 
A: Generally, an inheritance of assets such as property and shares is capital gains tax (CGT) free in the hands of the recipient upon probate.

In your particular situation, since the property has passed hands between various benefi ciaries I will take it one step at a time.

Person A acquired the investment property prior to 20 September 1985, and this therefore is a pre-CGT asset.

When Person B inherited the property in 1998, the capital cost base, for tax purposes, was adjusted to the market value of the property upon Person B inheriting the property in 1998. 
From 1998, this property ceased to be a pre-CGT asset. 

When Person C inherited the property in 2015, he also inherited the capital cost base of the property from 1998. As Person C also used the property as an investment property, the valuation that was done in 2015 is irrelevant for tax purposes.

When Person C sold the property in 2016, the capital gain on the property would 
have been the difference between the sale price in 2016 and the market value when Person B inherited the property in 1998.

As the property was held for more than 12 months (18 years in fact, for tax purposes, even though it was held in the family for 35 years), Person C will be entitled to the CGT 50% general discount concession (assuming he is an Australian resident for tax purposes and the property 
is not held in a company). 

“Generally, an inheritance of assets such as property and shares is capital gains tax free”

CGT is then payable on the remaining 50% at Person C’s marginal income tax rates.

For example, if the property was worth $300,000 in 1998 and the sales price in 2016 was $900,000, then this would mean a capital gain of $600,000. 

After applying the CGT 50% discount concession, the taxable capital gain would be $300,000, which falls into the top marginal income tax rate of 49% (including the Medicare levy and Temporary Budget Repair levy for taxable incomes above $180,000 for the 2016/17 tax year). Therefore the CGT would be close to $115,000, based on current ATO income tax thresholds.


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