Imagine you buy a property with the intention of moving in, but there is a tenant whose lease doesn’t expire for another 6 months so you keep renting and wait for them to move out so you can move in.
What are the CGT consequences of this?
Well, that property will always be subject to CGT as you did not move in straight after purchase.
But all is not lost because CGT will be minimal to almost nil where you remain living in the property for a number of years. Furthermore 3rd element cost base expenses can be used to reduce CGT even further.
Homer buys 123 Smith Street, but the contract indicates it is not vacant possession. It will come with a tenant with 6 months left on the lease.
Contracts signed on 1 July 2019, but Homer doesn’t move in until 1 Jan 2020, with a hangover.
Let’s say Homer sells that property in 2030, signing contracts on 1 July.
Will he pay CGT?
He might, but it may be a very small amount.
The first thing to consider is work out the time period it was rented as a percentage of the total ownership period.
6 months/132 months = 4.5%.
So, at the most the capital gain would be 4.5% x 50% x the gain or 2.27% of the gains on the property. Bugger all – note the 50% is the 50% CGT discount applied for holding the property more than 12 months.
But before this is done, the cost base has to be worked out. The capital gains is the sale proceeds less the cost base.
The cost base expenses include buying and selling costs and, importantly, the interest, rates, repairs and costs while living in the property can be taken into account here and they will further reduce any CGT, potentially bring it down to nil as over 11 years these costs would add up.
When someone dies their assets pass via their will, or intestacy laws, without triggering CGT. The beneficiary’s cost base of the asset is generally the same as the cost base of the person who left it to them.
Homer dies and leaves some shares to Bart. Neither Bart nor the estate pay CGT on the shares passing through to Bart. If Bart sells, he would pay CGT on the shares and his cost base would be the same as Homer’s cost base. So if Homer bought them for $100,000 and they were worth $500,000 on Homer’s death and Bart held them for 10 years and then sold them for $1mil, Bart’s cost base would be $100,000 and he would have made a capital gain of $900,000 (the tax would be about $210,000).
But if the shares are not sold but hung onto and the passed on via the beneficiary’s will, there will still be no CGT payable until they are sold.
Bart inherits Homer’s shares and then Bart dies. Bart some Bartyboy inherits the shares. If Bartyboy sells the shares his cost base will be $100,000.
So, the way to avoid CGT is for each generation of the family to keep the shares without selling. Selling the assets inherited is like killing the goose that lays the golden eggs.
Shares could be sold and later the proceeds reinvested, but each time they are sold up to 25% of the value is lost in CGT. Therefore, not selling for hundreds of years could allow for some massive compounding.
But what about the inflexibility of income distribution? One drawback of inheriting shares is that there is little opportunity to divert income to a spouse, and/or children unless they are held in a discretionary trust. Holding assets in a discretionary trust means those assets cannot pass via a person’s will. Trusts generally must vest every 80 years so that means CGT would be triggered every 80 years time, wiping out about 25% of the value of the assets.
However, there is a way around this too.
In this thread,
Tax Tip 194: Transferring a Property from a Testamentary Trust to a Beneficiary Without CGT https://www.propertychat.com.au/community/threads/tax-tip-194-transferring-a-property-from-a-testamentary-trust-to-a-beneficiary-without-cgt.38844/
I showed how it is possible to transfer assets out of a testamentary discretionary trust (TDT) to a beneficiary without triggering CGT.
Therefore, the solution to avoid paying tax is to set up a TDT in the will. Upon the death of the testator the assets will pass to one of more trustees of a TDT. Income from the shares can be streamed to the primary beneficiary and their spouses and children with real tax advantages (as well as asset protection).
When that primary beneficiary is about to die, or possibly even after their death, the assets of the trust, such as shares are transferred into their estate and then out into a new TDT. Their children will control this trust and can stream the income out and then upon their death, the same thing can happen.
The result is hundreds of years of compounding of the capital based with very little tax paid on the dividends in between – in theory, and assuming current laws allowing this will not change.
Homer is fit and healthy and writes his will incorporating a TDT for each child. Homer buys some shares and keeps compounding the returns so that at his death he has a large amount paying good dividends. His will leaves 1/3 to each of 3 TDTs each controlled by one of his children.
Bart controls one TDT and keeps the shares in it with the income being streamed to his children and spouse largely tax free. Bart keeps investing in shares outside the TDT (as injecting money into it won’t result in tax savings).
Bart comes down with a diagnosis of cancer and has 4 weeks to live. Dr Hibbert tells him the bad news and says sorry it has taken you 3 weeks to get an appointment to see me, you only have 1 week left.
Bart causes the assets to be distributed from the TDT to himself, without triggering CGT.
Bart dies a few days later.
Bart’s estate is now much larger than when Homer died.
Bart’s will also has a TDT and he goes for the same strategy.
Bartboy junior continues the tradition and does the same thing as his dad, Bart.
Bartyboy junior dies at a rave party, without children. But luckily his wills sets up a TDT with his siblings taking over the tradition.
This strategy can work well with shares as there is no stamp duty on the transfer of shares, but with property passing from a trustee to a individual is it likely to trigger duty in many states – perhaps exemptions might apply in VIC and WA in certain situations.
The best thing though is if one generation decides they want to sell up and abandon the tradition, then there will still be tax savings by utilising a Testamentary Discretionary Trust.
The main residence exemption only applies to land with a residence on it – a hint is in the phrase ‘main residence’!. If you were to demolish the house and sell the land you could be in for a nasty surprise as there would likely be CGT applicable. GST might be an issue also.
Homer purchased a main residence in 2010 for $1mil. It was dilapidated when he bought it and it has only become more run down since. Luckily the land value alone is now worth $2mil and Homer is negotiating with a developer.
They agree on $2mil on the condition that Homer remove the house.
Homer knocks the house down and stays in a 5 star hotel with a butler service for the full 42 day settlement period. It will cost him about $40,000 but, heck, he has earned it and deserves it for making a $1mil tax free capital gain.
Later Homer does his tax return and finds out that the main residence exemption cannot apply!
No problem says Homer, the value didn’t increase much by him knocking the house down.
However, Homer is shocked for a second time because the cost base of the property will be, basically, the purchase price plus costs such as stamp duty and a few other fees and charges and the demolition cost. Perhaps $1.1mil in this case. This could mean a capital gain of about $900,000.
That would be about $450,000 additional income for Homer, how as head scientist at Lucas Heights is already on the top tax rate which means he has made a mistake of about $211,500 plus the $40,000 for the hotel!
Had Homer sought advice there may have been a way to structure this so that the main residence exemption remained, and the demolition occurred.
Strategies to keep the exemption may be to pay for the demolition after settlement, or to give the developer possession before settlement or just reduce the price by the cost of demolition.
Posted 21 Jun 2019
Working as a trainee lawyer in a small suburban firm I heard a staff member, who wasn’t even a lawyer, tell a conveyancing client that the relevant date for CGT purposes is the date of settlement and not the date of contract. How wrong she was.
Generally*, where a capital asset is purchased or sold under a contract the relevant date for CGT purposes is the date the contract is entered into, s 104-10(3)(a) ITAA97 (CGT event A1).
Timing is very important if an investor wants to sell the property about 12 months after buying it because a few days difference can mean a lot of extra tax .
Bart buys a property on 28th of June for $500,000– he enters contracts on this date, but settlement is on 28th of July. The relevant acquisition date for CGT purposes is 28th of June. Bart gets a keen buyer interested in the property and they want to sign the contract to purchase it on 27th of June the following year for $1mil with settlement on the 1st of August. Bart thinks, great that is more than 12 months from settlement to settlement so he thinks he will get the 50% CGT discount.
But Bart is wrong because it is the contract dates that count – 28th of June this year and 27th of June next year. Less than 12 months so no 50% CGT discount.
Bart’s capital gain is $500,000
Had he sought advice and waited 2 more days his capital gain would have been $500,000 still, but the taxable capital gain would have been halved to $250,000.
Timing is also very important as to which financial year the gain will be taxed in.
Lisa is selling her investment property and is in negotiations with a prospective buyer. It is late June and Lisa wants to make sure the gain is taxed in the next financial year as she will be off work all year and will have no income. This year she has already earnt $200,000 in taxable income.
Lisa signs contracts on 1 June this year with settlement on 15th June next year. She thinks the relevant date is the settlement date. The gain before the discount is $200,000.
If the sale falls into this financial year the tax would be $47,000
If the sale falls into the next financial year the tax would be $25,717
(based on 2018 and 2019 tax rates respectively)
*Note that I said ‘generally’ at the beginning above, and that is because there are instances where the relevant date is the settlement date, and sometimes it is somewhere between the date the contract is signed and settlement happens. I will cover these in a future tax tip.
17 Jun 2019
Below are some ways in which CGT may be reduced on the sale of an investment property. But before you decide to sell you should properly work out what the potential size of the capital gain will be. Once you know what you are dealing with you will then be able to work out appropriate strategies to reduce the amount of tax payable.
1. Timing of the sale
Usually it is the date of the contract entered into that is the relevant disposal date for CGT purposes. Some things you can do:
a) Bring forward the sale so that it falls into a year of low income, or
b) Push back the sale so that if falls in a later year where you expect to have lower than usual income. Delaying the sale can also allow for more time to plan and implement other strategies.
c) Time the crystallising of losses (see below)
d) Make sure you have held the property for the full 12 months for the 50% CGT discount
2. Offset Capital Gains with Capital Losses
Capital Losses can be used to offset capital gains. Losses can result from:
a) Carried forward losses from prior years, or
b) Current year losses arising from the sale of other assets.
Bring forward the sale of other property or shares that have dropped in value may help. But you have to get the timing right. Selling the shares with the capital loss in a later tax year to the sale of the property with the capital gain will result in no offsetting and the capital loss being carried forward to be offset against some future potential capital gains.
Take care with the sale of shares and then immediately buying them back as the ATO may want to deny the deduction as they can deem this to be a wash sale with the sole purpose of a tax benefit.
3. Claim everything possible
When working out the capital gains tax the cost base of the property needs to be worked out. Various expenses incurred during ownership can be used to reduce the amount of CGT payable. So it is essential not to miss any potential deduction as this will result in more tax being payable.
See my tax Tip on this: Tax Tip 76: Calculating the Cost Base for CGT purposes.
4. Small Business Concessions
Often overlooked are the small business concessions which may be used to reduce the CGT (sometimes to nil) where the property has been used as part of a business.
There are 4 main small business CGT concessions, namely:
a) the small business 15-year exemption
b) the small business 50% active asset reduction
c) the small business retirement exemption and
d) the small business rollover
@MikeLivingTheDream first gave me the idea of using the 4 small business concessions.
5. Reducing your Taxable Income
Any capital gain is added to your other taxable income for the year so look at ways to reduce your income. There are 2 aspects to working out taxable income:
a) Earnings, and
Either reducing earnings or increasing deductions will result in less tax, Combine the 2 and your savings will be greater still.
5a. Reduce Earnings
Not many would want to reduce their earnings, but here are some suggestions for those that do:
• Taking that leave without pay that you always wanted may work in well with reducing your earnings;
• Salary sacrificing into super can also reduce your taxable income;
• Change from full time to part time;
• Quitting to travel the world.
• Where self-employed you may be able to delay income.
• Salary sacrifice into super
See Taking a Year off Work to save CGT
Before prepaying interest, you should consider the flow on effects for later years – where you will have little to no interest claimable which may result in more tax payable. Also, be aware that you cannot just pay into the loan, but must actually fix the loan for 1 year and
5b. Increase Deductions
Having greater deductions will mean you have less taxable income. Some ways to increase deductions, other than the usual claiming everything you can, are:
• Prepay interest on other investment properties
• Deductible contribution into super where possible.
6. Die in your investment property
As you approach death move into your investment property with the biggest gain and rent out the main residence.
Usually, it is difficult to get the timing right on this one!
Stay tuned for Part II
Get some legal advice before trying this.
Some people want to help their elderly parent(s) purchase property. This might be the parents moving to a more suitable property or the parents becoming owners instead of renting.
Helping the parents into a property can also help the children too, because they may potentially inherit the property at a later date and there can be great tax concessional along the way.
There are basically 3 main ways an adult child could help a parent into a property:
b. loan – at interest or interest free
c. purchasing part of the property.
There are various estate planning consequences to each of these and also practical consequences.
Some things to consider:
An example of how It could work
Bart and Lisa are adults with one parent left – Homer. Homer lost his house years ago and is renting. Bart and Lisa each have their own homes fully paid off and some cash in the offset accounts to their separately owned investment properties.
Bart finds a property with development potential. It is just around the corner from where Homer lives in his rented flat. Bart is going to purchase the property and is deciding what entity to put it in when he has an idea.
The property purchase price is $500,000. He has enough cash to pay for it so he could just buy it outright, but since his dad is not getting a main residence exemption for CGT Bart talks to Homer, his dad, and they decide to buy it in Homer’s name.
Homer signs the contract and Bart lends him the 10% deposit with a promise to lend him the rest for settlement.
Bart then realises that if Homer dies his sister Lisa will end up with half the property. So to make things fairer he talks to Lisa and gives her 2 options
Bart and Lisa decide to ‘go 50/50’ and each lend Homer $250,000 and Homer settles on the property. It is a 5 year interest free loan which they intend to renew each 5 years.
Bart arranges various approvals and the property is now worth $1mil when Homer dies 4 years later.
Under the terms of the will of Homer 50% of his assets would go into each of 2 testamentary discretionary trusts with one controlled by Bart and one controlled by Lisa.
They each now have 50% of an additional property which would be could be sold tax free or held onto with a cost base of $1mil. There has been no land tax along the way because this was Homer’s main residence and they have each gained further tax deductions by using cash in their offset accounts.
Furthermore, any income generated from the property from that point could be streamed to their minor children, as beneficiaries of the trust, with each child getting around $20,000 without having to pay tax.
Just before Homer’s death they also forgave the loans they made him – so this meant that an extra $500,000 was driven into the testamentary discretionary trust so they could generate even more tax free income.
Legal Tip 208: Helping an Elderly Parent Buy a new property https://www.propertychat.com.au/community/threads/legal-tip-208-helping-an-elderly-parent-buy-a-new-property.39377/
Written by Terryw Lawyer at www.structuringlawyers.com.au
Under s118-150 ITAA97 a person can claim the main residence CGT exemption for up to 4 years prior to occupation of a house being constructed once it is completed – if they live there for at least 3 months and do not claim another property during this time.
Tax Tip 99: Vacant Land and the CGT Exemption https://propertychat.com.au/community/threads/tax-tip-99-vacant-land-and-the-cgt-exemption.9196/
Tax Tip 107: CGT exemption not stay in newly constructed house for 3 months https://propertychat.com.au/community/threads/tax-tip-107-cgt-exemption-not-stay-in-newly-constructed-house-for-3-months.9696/
What would happen if the owner died during construction and could not live there for 3 months?
Luckily there is a concession which covers this scenario and can be found at s 118-155 ITAA97. The surviving joint owner of a joint tenancy or the LPR of the estate can choose to apply the main residence rule for the shorter of 4 years before the death or when the individual acquired the land.
Homer and Marg are renting and buy land with the intention to build on it. The land has skyrocketed in price, but after 3 years they still have not done anything with it. They then realise time is running out so enter into a contract with a builder. Homer suddenly dies from radiation poisoning. If Marg is a joint tenant owner she will become sole owner bypassing the will. This legislation allows Marg to claim the main residence exemption on the whole property from the date it was acquired as long as she moves in within the 4 year period from purchase contracts.
If Barney was Homer’s executor and they held it as tenants in common it could still be CGT exempt as long as it is completed in time. In this case Barney doesn’t need to move into the property for the exemption to apply but it can be passed via Homer’s will as if it was Homer’s main residence for the 4 years prior to his death.
I had a client recently who was selling this main residence. He was shocked when I told him it would not be fully CGT exempt as it was about 8 acres in size.
The main residence CGT only applies to a dwelling on land of up to 2 hectares in size. So when the land is larger than 2 hectares only part of the property will qualify for the main residence exemption.
See s118-120(3) ITAA97.
Note that the 2 hectares can be selected on the most valuable parts of the land which need to be adjacent to each other. For example you might have the land under the house on one side and the land under a shed way down the back, but not count the land in between them.
See TD 1999/67
Which includes this diagram:
Written by Terryw tax lawyer at www.structuringlawyers.com.au
Trusts are generally considered the greatest British invention, (the sandwich comes in second), and Testamentary Discretionary Trusts (TDTs) are the best of the best.
The main benefit of a TDT is the ability to get income into the hands of children and have them taxed as adults.
Another main benefit of TDTs is the ability to transfer a property owned by the trustee of the trust to that of a beneficiary of the trust without triggering CGT. This means an inspecie transfer of assets is possible without CGT.
Homer dies and leaves his property portfolio indirectly to his children by establishing 3 separate TDTs in his will. Bart’s trust will hold 3 properties, as will 2 more trusts controlled by Bart’s sisters.
Bart has 5 children, so is able to distribute the $100,000 in rental income to the children tax free each year.
After a while the kids grow up and start working so any further distributions will result in tax being payable at high rates. Bart decides to reduce the tax by moving into the most expensive property and living there rent free. Then he realises that the property is subject to CGT as it is held by a trustee and the main residence exemption won’t apply.
Bart decides to use the ATO’s concession and transfer the property from the trustee to himself as a beneficiary under the will.
He gets a private ruling first and this confirms the Commissioner will not treat this as a disposal for CGT purposes because it is a transfer from a deceased estate to a beneficiary.
Note however that this is not law, but a concessional treatment by the Commissioner as stated in Paragraph 2 of PS LA 2003/12 https://www.ato.gov.au/law/view/document?docid=PSR/PS200312/NAT/ATO/00001
“… the Commissioner will not depart from the ATO’s long-standing administrative practice of treating the trustee of a testamentary trust in the same way that a legal personal representative is treated for the purposes of Division 128 of the ITAA 1997, in particular subsection 128-15(3).”
See also PBR 99991231235958 – Questions 1 and 2
also PBR 1012603789935
There is no time limit as to how long you can carry forward losses – whether income losses or capital losses, however they will be lost at death (a loss lost!). So, it makes sense that you should try to use up losses as early as possible. This is generally not too hard with income losses as these are easily eaten up the next financial year with more income being earned.
Using up capital losses tends to be more difficult though as a capital loss can only be used up by a capital gain – not general income.
Note that there are complex rules regarding companies and trusts in carrying forward losses.
Homer invested money in a business he ran which failed. He lost $200,000 and has a $200,000 capital loss which he has been carrying forward for 9 years now. Homer would love to use this loss up, but the trouble is he has no other asset he could sell to offset the loss.
If Homer owned shares for example he could sell shares with a $200,000 capital gain and not have to pay any tax.
But losing his money has meant that Homer doesn’t have any capital to invest with.
However, Homer’s daughter Lisa knows a thing or 2 so sets up a discretionary trust to hold investments. It could be possible that in future a gain from the trust could be distributed to Homer and his loss could offset this so that no tax is payable.
Discuss this topic here
I have outlined what a declaration of trust is here http://www.structuring.com.au/terry/trusts/declaration-of-trust/ .
What are the CGT consequences of a person declaring that they now hold an asset as trustee? There is no change in title, so most people probably think there are no tax consequences, but there are.
CGT Event E1 (section 104-55(1) ITAA97) happens when someone declares a trust over existing property they own. This is because there is a change of beneficial ownership, even though the legal ownership remains the same.
Homer holds 100 shares in CBA. He makes a declaration of trust that he now holds these shares on trust under the terms of the Simpson Family Trust deed. No change of ownership has happened, but this has triggered CGT just as if there was a sale of those shares to a 3rd party. If the cost base of the shares was $100,000 and the market value is now $200,000 that would mean a $100,000 capital gain is made (which may then get the 50% CGT discount etc).
(Homer should have sought legal advice as there are ‘better’ ways of doing this)
Some people have carried forward capital losses. These losses can usually be carried forward until the taxpayer has a capital gain which can ‘soak up’ the capital loss.
I think it is a good idea to use up these losses as soon as possible.
The main reason being that losses are ‘lost’ at death. If the taxpayer dies their loss cannot be passed on to any other person who could utilise it. Don’t lose a loss!
Bart bought a property in a mining town for $1,200,000. He ended up selling it for $700,000 and has a carried forward capital loss of $500,000.
Bart dies and leaves a rental property that he owns to his sister Lisa. The property has a $500,000 capital gain.
Unfortunately, Bart’s loss will not benefit anyone. Lisa will inherit the investment property pregnant with a $500,000 gain, yet she cannot benefit from the loss.
Had Bart sold the investment property before his death he might have made $500,000 tax free and this money could have been passed onto Lisa. He might have even sold the property to Lisa – perhaps with vendor finance if she couldn’t have afforded a loan. Also, if Bart had a flexible will his estate could have sold the property and possibly used up the gain.
Another reason to use up capital losses is their benefits with debt recycling. Making capital gains without needing to pay tax will mean there is more money with which the non-deductible debt can be reduced.
Example of Debt Recycling
Lisa has a $100,000 capital loss from some bad share investments many years ago. Because of this she has a large amount of debt still outstanding on her main residence. But this has not stopped her investing in shares again. She has learnt from her mistakes and is now making some good capital gains.
If Lisa’s shares increased in value by, say $20,000 in the first year, she could sell these shares, pay no tax, and use the proceeds to pay down the non-deductible debt, and then invest in more shares and repeat.
Doing this has 2 advantages
Speak to your tax lawyer or tax agent.
If someone sells a property and has a large capital gain is it worthwhile taking a whole year off work to save tax? In my view it is always great to take a year off work, but it might not actually save you that much tax.
Richie Rich is about to sell an investment property with a $200,000 capital gain. He is sick of it under performing and draining him with land taxand has a low yield. Richie is toying with the idea of taking a whole year off work to save CGT. Is it worth it?
Let’s assume Richie earns $100,000 in his job, and the sale will happen in the 2018-2019 financial year.
If he sells the $200,000 gain will be reduced to $100,000(due to holding it longer than 12 months) and added to his other income for the tax year. The result is an annual income of $200,000
Tax on $100,000 $26,117 Net income $73,883
Tax on $200,000 $67,097 Net income $132,903
Difference $40,980 Difference $59,020
The Capital Gain will mean $40,980 in extra tax payable for the year.
This means by giving up a year’s income from work Richie would only earn $100,000 from the capital gain. Therefore, he will save $40,980 in tax by not working.
But not working means he has less income, working the full year in which the sale occurs will net him only $59,020 as opposed to his normal $73,883 (a difference of $14,863).
He would need to determine if the effort of working is worth the pay cut of $14,863 which is about $286 per week.
He should also factor in transport costs to work and other work-related costs – clothing, lunches etc. and there are also heaps of non-financial things to consider. There would be time to do other things such as:
Written by Terry Waugh of www.structuringlawyers.com.au
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.
1. CGT Tax is only payable at the end so greater compounding during the life of the investment
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