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Monthly Archives: October 2018

Forgotten land Tax

I have met some people who have forgotten to claim land tax and/or thought they were exempt but were later caught out. Land tax can only be claimed in the year in which it relates to – not the year in which it was paid. ATO ID 2010/192 (now withdrawn, but law still current).

In some cases it will be too late to amend tax returns and these land tax costs will not be able to be claimed for prior years.

I had a call from an old friend who has a trust which owns 3 rental properties in NSW and has held them for about 10 years – yet they have never paid land tax and didn’t really know about it until I asked him how much he was paying.

The problem is when the property is sold the land tax clearance certificate will not be clear and he will have a large sum payable before settlement. Yet they will probably not be able to claim more than 2 years. As the trustee is liable this will also affect the distributions the trust has made and it will be messy to fix so there would be additional tax agent fees.

So if you haven’t done so already register for land tax and pay it as it is incurred.

Written by Terry Waugh, lawyer at Structuring Lawyers, www.structuringlawyers.com.au

keep All Receipts forever

By law you are only required to keep receipts for about 5 to 7 years. But for tax this is 7 years after you claim an expense.

You should always keep your receipts just in case. If you move out of the main residence and rent it at some stage then the expenses incurred when you were living there can be used to reduce the CGT payable. However you may not sell the property for another 50 years so you will need to keep receipts this long if you want to save tax.

When someone dies and their property is inherited by someone else the cost base of the deceased will often be the cost base of the property for the person that inherited the property. So expenses incurred when the deceased was alive and living there or renting the property out can be relevant to the tax of the person that inherited the property.

If there is a capital loss that is carried forward receipts relating to the loss should be kept from at least 5 years after it has been used up in full.

Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au

Using Redraw to invest

Withdrawing from a loan is considered new borrowings for tax purposes. So the same principles apply as to all loans. It is generally the use the borrowed funds are put to that determines deductibility. The security of the loan does not matter for tax deductibility reasons.

The reason that using redraw is generally a ‘no no’ is that it usually results in a mixed purpose loan. If there are other monies which have been drawn down and used for other things then increasing one loan to buy a property will result in a mixed purpose loan. See my other tip on why not to mix loan purposes.

So unless your loan account balance is $0 it is best not to use redraw but to set up a new split before borrowing.

However where your loan is Interest Only it is possible to use redraw and to later split the loan into the relevant portions. If doing this you should not make any deposits to the loan account other than interest.

Ideally you would split before borrowing but some people buy property at short notice with no planning and in these cases it would be better to use redraw than to use cash to pay the deposit as a mixed loan can be unmixed later – see Tax Tip 44.

The main point is that using redraw will result in a mixed purpose loan – unless the redrawn amount is used for the same purpose as the underlying loan. So avoid redrawing if possible.

Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au

Reimbursing yourself – Impossible

It is impossible to reimburse yourself with borrowed money after an asset has been paid for and claim the interest

Interest will only be deductible if borrowed funds are used to produce income.

Where people get into trouble with this sort of thing is when they don’t plan ahead, but may pay a 10% deposit using cash before they have the loans sorted out. Once a deposit is paid in cash it is paid. If you later borrow an equivalent amount from a loan increase and ‘pay yourself back’ the interest on this loan cannot be deductible because the interest does not relate to a loan used for the property.

So, before you pay any money for a property make sure you get the loans set up so that you can borrow to pay for that property.

On a $500,000 purchase a 10% deposit is $50,000.

A $50,000 cash payment, while you have non-deductible debt on the main residence, will result in about $2,500 per year in lost deductions ($50k x 5%). That is per year for the life of the loan. That could cost the average person $1000 per year out of their pocket – enough for a trip overseas each year.

Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au

The Pleasures of CGT: 5 Reasons Why CGT is better than Income Tax

It is not often that you use the words ‘pleasure’ and ‘tax’ in the same sentence, but if you had a choice of income tax or Capital Gains Tax (CGT) it would be more pleasurable to pay CGT.

Here’s why:

1. CGT Tax is only payable at the end so greater compounding during the life of the investment

Example

2 investments of $100,000:

A. one returning 0% income with 10% capital gains, or

B. One returning 10% income with 0% capital gains.

Same overall return but different tax consequences.

 

In year 1

A will be worth $110,000 but no tax payable yet,

B will be worth $100,000 with income of $10,000 so up to nearly $5,000 lost in tax.

 

In year 2

A will be worth $121,000

B will be worth $105,00

Each returning the same 10% again.

If this continues the gap between A and B will widen each year.

 

2. Can be avoided completely on at least one and possibly 2 properties

The main residence exemption means one asset can be completely tax free. Careful planning can allow for 2 properties to be totally exempt for the whole ownership period.

3. The 50% CGT discount

Once the tax is payable most taxpayers will actually get a 50% reduction in the tax payable because of the 50% CGT discount. This applies for assets held longer than 12 months. It doesn’t apply to income received more than 12 months!

 

4. Personal expenses can reduce it

Move into an investment property and costs incurred while living in the property can be used to reduce the eventual CGT – potentially to nil. These are the 3rd element cost base expenses and include interest, rates, repairs, insurances etc. You can’t do this with income.

 

5. Time to Plan

CGT can be minimised by careful planning. This can involve timing strategies, bringing forward other expenses and other strategies some of which I have outlined at: Tax Tip 119: How to Reduce CGT on Investment Property (Part I)            https://propertychat.com.au/community/threads/tax-tip-119-how-to-reduce-cgt-on-investment-property-part-i.10681/

 

Written by Terry Waugh, solicitor at www.structuringlawyers.com.au

Stamp Duty Exemptions for fixing Mistakes

Sometimes mistakes happen when registering property ownership. Ownership may be registered in the wrong percentages for joint owners for example. There are exemptions available to fix mistakes such as these without the need to pay duty a second time.

One example seen recently was where the client had owned the property 50/50 with their spouse. They didn’t realise this mistake until refinancing many years later and having a solicitor look over their situation. Evidence was produced that they requested the ownership be 99/1% but their original conveyancing solicitor disregarded or missed this when preparing the transfer and as a result the ownership ended up as tenants in common in equal shares.

This was rectified under section 65(14) of the Duties Act NSW without the need to pay additional stamp duty and the ownership ended up with the originally intended 99/1% split as tenants in common.

Normally changing from 50/50 to 99/1 would have resulted in duty being charged a second time on 49% of the property value.

 

Written by Terry Waugh, solicitor at www.structuringlawyers.com.au 

 

Parking borrowed money in an offset account

I Thought I would start some tax tips so I don’t have to keep repeat typing the same thing over and over again.

Many people borrow money and deposit that borrowed money into a savings account or an offset account and then later use that money to invest. In these cases, will the interest be deductible?

The answer is “Maybe”!

In relation to investing, under s8-1 ITAA97 an expense is deductible if it is incurred in gaining or producing assessable income. Interest is generally deductible under this section. But problems can arise where the ‘incurring’ is not directly connected with the investing.

In a legal case from 2004 Mrs Domjan borrowed money, and moved it, briefly, from the loan account into a savings account to write a cheque. The savings account contained other money which was not borrowed. So when she wrote the cheque to purchase an item for her investment property it could not be said that Mrs Domjan had used the borrowed money – it could have been the cash in the account.

The connection between the borrowing and investing was broken by the borrowed money taking a detour before investing.

Some have argued that where the savings account is empty then there will be no co-mingling of borrowed and non-borrowed funds if the loan is drawn down into this account. This is true, but where interest is incurred on the borrowed funds it cannot be deducted as there is no income generated. However, where the savings account is an offset account there is no interest incurred at all as the borrowed money is in the offset offsetting the loan. If this borrowed money is later used for investment, then the interest will start to be charged on the loan. My opinion is that this interest can be traced to the investing and the interest should be deductible (assuming no mixing).

However as far as I know there is no legal or ATO authority to say this is correct, except for one private ruling that I have found – see Private Ruling Authorisation Number 57920.

Question 1 of this ruling is the relevant question here. Note that the circumstances to this question differ from our scenario of ‘topping up a loan’ as this situation involves the taxpayer borrowing extra at the purchase, similar but slightly different, to a person accessing equity by further borrowings.

This private ruling cannot be relied upon by anyone other than the person who applied for it – within the dates listed.

So, in summary

  1. Borrowing money to park in a savings account will probably result in the interest being NOT deductible.
  2. Borrowing to park in an offset account may result in the interest being NOT deductible where the offset contains other non-borrowed money. The interest could possibly be deductible in part.
  3. Borrowing to park in an offset account may result in the interest PROBABLY being deductible when the offset funds are used to invest at a later date.

Where an offset account is involved it is very easy to get mixed up or confused with account numbers etc. and to inadvertently deposit non-borrowed money into the account. This is harder to do with a loan account and the effect is less as any deposit can be left there without contaminating the loan. Where borrowed money is in the offset and non-borrowed money is deposited into that account it will be impossible to rectify. It would be like putting a drop of urine into a cup of tea – you can’t take the urine out again. If you think you can, would you drink the tea?

To avoid the risks of ruining deductibility I suggest a better way to proceed would be to use an Interest Only loan where you can draw down the funds at settlement and put them straight back into the loan. The funds can sit there until needed and then be re-borrowed from the loan at the time of investing. Or the funds can stay in the offset, and then go back into the loan a few days before re-borrowing again to invest.

Alternatively use a LOC product. These allow a credit limit with funds capable of being drawn (i.e. borrowed) when needed. The disadvantage with LOCs is the higher interest rate and the fact that these loans are often (but not always) without a fixed term and can be called in by the lender at short notice. However, once the money is actually used the LOC could also be converted to a term IO loan. This way you get the best of both worlds.

And keep in mind:

Even depositing rent in an offset containing nothing but borrowed money will contaminate the loan. If the offset contains the borrowed money only you can trace it back to the borrowings, so the interest will PROBABLY be deductible (see tax tip 1). But as soon as you mix non-borrowed money in an offset containing only borrowed money it will be contaminated and AT BEST you will have to apportion the interest. Doesn’t matter what the source of the money is.

See

Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au

Can a Trust Distribute Franking Credits to Someone Other than the Dividend Recipient?

No.

Franking credits are not income as defined in the tax acts nor are they assets of a trust. They therefore cannot be allocated to someone, but they must flow out as directed by Division 207 of the ITAA36.

It was previously thought that the franking credits could be distributed separately but this ‘bifurcation assumption’ was recently held be to be legally ineffective by the High Court in the case of Federal Commissioner of Taxation v Thomas [2018] HCA 31

Written by Terry Waugh, Solicitor at www.structuringlawyers.com.au

2

Transactions to Defeat Family Law Claims

Section 106B of the Family Law Act allows a court to set aside certain transactions designed to defeat an existing or proposed order relating to a party to a marriage or defacto relationship.

This can include transactions that are:

  • Gifts
  • Sales
  • Bankruptcy related
  • Rights attaching to an interest in a company or trust
  • changing Appointor positions in trusts
  • Varying powers under a trust

Example

Bart is about to divorce his wife and resigns as appointor of the family trust and appoints his friend Millhouse. Bart also causes the trust to be varied so that neither Bart nor his wife are beneficiaries of the trust. The trustee is also controlled by Millhouse.

Bart then gifts money to the trustee of the trust. Bart borrows this money back and lets the trustee take a mortgage over his house as security for the loan. Bart sells another property he owns for $1 to the trustee of the trust.

This series of transactions involving Bart could be attacked in several ways. Including:

  1. Court reversing the amendments to the trust
  2. The gift could be clawed back
  3. The loan set aside
  4. The mortgage set aside
  5. The transfer of the property could be set aside.
  6. The court may not do any of the above, but to simply take the value of the assets into account when working out the division of property between the spouses.

Keep in mind that just because a transaction can potentially be attached does not mean that you should not do this.

Legal advice should be sought if seeking asset protection.

Written by Terry Waugh, lawyer at Structuring Lawyers, www.structuringlawyers.com.au

Who will look after your minor children if you die?

What happens when both parents die early and minor children are left behind?

The children must come under the care of a guardian. You can appoint a guardian by your will. (for example in NSW s 14 Guardianship of Infants Act 1916 (NSW) gives a parent this power)

If there is no guardian appointed under a will, someone, perhaps grandparents, will need to apply to a tribunal to be appointed guardians

Often there may be a dispute about who will be guardians – two sides of a family fighting it out for example – and this would necessitate the tribunal or court to make a decision. In NSW the relevant legislation is Guardian of Infants Act 1916 (NSW)

 

Some of what to consider when appointing a guardian

  • Will they accept the role?
  • Where does the guardian live?
  • Should they be compensated (via your will)?
  • Is their accommodation suitable?
  • Should they be allowed to use some of the children’s money to extend their house? (a court has said yes in at least one case);
  • How old are they?
  • What If they die?
    • Before you, or
    • Before your kids become 18.
  • Do they get on with your children now?
  • Do they follow the wrong religion?
  • Are they connected with a circus?

This is another reason to consider a will even if you do not have any assets.

 

Written by Terryw of www.structuringlawyers.com.au

 

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