The assets test can prevent someone from getting a full or part aged pension. A way around this might be to ‘double dip’ by spending up to reduce your assets. But that is wasteful. Spending $150k wastefully just to get an extra $10k doesn’t seem to be wise (yet people actually do this!).
A better way would be to upgrade the main residence. But this is also wasteful in terms of suffering stamp duty and other costs – you will lose roughly 10% of the value in selling one house to acquire another.
Another solution is to build a granny flat or second dwelling in the existing house. This will use up a chuck of cash, but also add value to the property.
As long as the granny flat is not rented out, or family stay there it will be treated as a part of the main residence and there will be no income taken into account.
This could help a person both get the pension as well as help family out by allowing them cheap accommodation.
Section 11A(1) of the Social Security Act
As of July 2019 the assets test for a single pensioner is $258,500 for a home owner. That is a single pensioner can have assets of $258,500 or less, other than their home, and still get the full pension.
Homer’s wife Marge just died and he is on a single pension. He has a $400,000 house on a large block as well as $400,000 in the bank. Homer could get a part pension only with his assets exceeding the assets test level.
His pension would be $12,836 per year
If he used $141,500 to build a granny flat the pension would jump to $22,509 pa
Using this great calculator: http://yourpension.com.au/APCalc/index.html#CalcForm
Homer uses $141,500 to build a granny flat in the back yard.
His pension increases by almost $10k per year.
He let’s his son Bart stay there and Bart helps around the home. Bart is now saving $300 per week on rent – so he is $15,000 per year better off.
If Bart moves out or if Homer ever needs more money he can always rent the granny flat out, but this would reduce his pension. If he rented the flat out for $300 pw he would get $15,000 pa rent plus $16,377 for the pension. $31,377 pa
He could also sell the property by about $180,000 more with the granny flat
So, all up building the granny flat has benefitted Homer in at least 4 ways:
Retirement can be funded from 5 basic classes of income/assets, which are:
Income is the obvious one. You invest in shares or property and receive dividends or rents. You could also work if you had to.
Capital gains is also relatively obvious, but often not considered by the ‘never sell’ type.
Capital gains are often better than income because they are taxed at half the rate of income (using the 50% CGT discount). Capital gains can be obtained by selling longer term held assets such as shares or property.
Capital, or Corpus, is not usually considered directly, but many financial planners and government websites assume you will eat into your assets so that on the day you die you will have $1 in the bank. This is similar to capital gains, but different because you are eating into the original cash you have contributed to the investment there is no tax payable.
This could be cash in offset accounts – which can be a great way to fund retirement as where the offset is attached to an investment loan the increased interest will be tax deductible.
It could also be from the proceeds of shares of property after they are sold.
Borrowing is still possible, but it will be very unlikely most people will be able to utilise this in their retirement. One way to possibly do it is to borrow as much as possible just before retirement and to slowly use these funds. Another way is the reverse mortgage products.
One method rarely considered though is borrowing from children to fund your retirement. This can benefit both parent and child because instead of selling that property and losing future growth, paying extra tax etc, the child could lend you some money on the expectation of inheriting the property at a later date.
The pension is the backup strategy for many– government will fund your retirement if all else fails. Some can also get a part pension combined with part from one or more of the other classes above.
Note that I didn’t include superannuation as a separate category above, as income from super wil be in one of the above forms anyway.
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
Testamentary Discretionary Trusts (TDT) are the best sort of trust out there, but someone has to die for them to come into existence. So, they are relatively rare. Also, the capital of the trust has to come from the deceased for the extra tax benefits to work (excepted trust income).
So, I cringe when clients approach me wanting to wind up a TDT that their parent has left them in control of.
Their idea usually goes something like this. I have a $1mil loan on my main residence and the trust holds $1mil worth of assets. If I wind up the trust, I can pay off my home loan and save interest.
It is a valid point, but once a TDT is closed it can’t be reopened again, and even if kept open new capital can be injected, but income generated from it would not qualify as except trust income and would not get the concessional tax treatment in the hands of children.
There is a simple way around this though, and that is to get the trustee to make you an interest free loan.
Bart’s dad Homer dies and leaves $1mil to a trustee of a TDT set up under his will. Bart has a $1mil home loan so winds up the trust and pays off the loan.
Lisa is in the same position, but she controls a separate, but identical trust. Lisa gets the trustee to lend her $1mil interest free which she uses to pay off her loan. She has not no deductible debt now. So, she uses the $3,000 she was paying the bank each month to pay back the trust.
The trust now has money with which to invest. The income from these investments can go to Lisa’s children tax free – because they can each earn $20,000 pa tax free so it will be ages before the trust’s income is more than this.
Meanwhile Bart is making the same investments as Lisa, but he receives the income himself and is taxed at 47%
Over the next 15 years or so Lisa would have probably repaid the full $1mil back to the trust so it is now generating about $40,000 per year in income which comes out tax free to her kids.
Once the kids start working, she will have to reassess where the income goes, but until then there are huge savings.
Tip – Don’t wind up a testamentary trust without careful consideration and legal advice.
Note that this would also give great asset protection as well.
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
Some investors end up selling a property or shares at a loss. They may have borrowed to acquire the property or shares but the sale proceeds may not be enough to pay out the loan – they probably would have used another property as security for at least part of the loan.
In certain circumstances it is possible to keep claiming the interest on the loan in these cases even when there is no income coming in.
Bart bought a property in a mining town for $500,000 and he borrowed $400,000.
The property dropped in value to $300,000 and the bank has let him sell the property but to continue with an unsecured loan of $100,000 (it does happen).
Generally, the interest on Bart’s loan would continue to be deductible as long as he does not try to artificially increase his benefits by extending the loan term, increasing the loan etc. Also, Bart’s case would weaken if he happened to have $100,000 cash in a savings account.
If you are going to be selling at a loss seek tax advice well before hand so you can potentially set yourself up for much more in tax savings which could help you reduce the pain on the loss.
Seek tax advice well in advance of selling – from your tax agent or tax lawyer.
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
A Bucket company is a company set up to receive profits from another entity – usually a discretionary trust. The bucket company usually does nothing else, except receive money and make loans or directly invest perhaps. Over time the value of the bucket company will rise as money is coming in but not going out. Therefore, it will become increasingly important to consider in regards to estate planning and asset protection.
One estate planning strategy is to set up one separate bucket company for each child so that when the controller of the companies dies each company’s control can be passed on rather than having multiple people inherit the control of one company.
Homer has 3 kids. He wants to leave them approximately the same amount of his assets 1/3.
Homer has decided to set up a discretionary trust to use to invest in shares. He seeks legal advice on the difficulties with leaving the control of the trust to more than one person so has that covered. But after a while the dividends of the share investments are building up so Homer sets up 3 bucket companies with 3 separate discretionary trusts with one trust holding the shares in each bucket company.
When the dividends come in, he causes the trustee of the share trust to distribute 1/3 to each company. Over a period of time the companies end up with large amounts of retained earnings which and then lent back to the share trust.
Each of the bucket companies is then passed to each child – actually nothing is passed but the control of the bucket companies is arranged so that Child A controls Trust A and Bucket Company A.
This way things will be easy to divide. There is no more than one child involved in one company so if they want to cause the company to make loans, invest, pay dividends or close down they can do so without the need to effect or even consult with their siblings.
For a Discussion go to:
If you moved to a cheaper area to live and took a haircut on your wage, it might not be as bad as you think. This is can speed up financial independence and reduce stress and give you a better quality life.
Example of a $20,000 wage reduction
After tax income on $100,000 would be $73,883 (2018-19 tax year)
After tax income on $80,000 would be $61,383
So, a $20,000 reduction in gross income means only a $12,500 reduction in real terms
Try working it out yourself at https://www.taxcalc.com.au/
But the real benefit may be the savings with home ownership.
An equivalent house costing say $1mil in Sydney v $600,000 in Adelaide (for example)
Repayments on $1mil at 4% pa are
Repayments on $600k at 4% pa are
The repayments on the smaller loan mean a cash flow saving of $22,920 per year – which more than makes up for the lower wage income.
Furthermore, if you consider commuting times – you might be saving 1 or 2 hours per day living outside of Sydney.
Living costs may also be generally cheaper. Consumer prices are supposedly about 12.75% higher in Sydney than Adelaide:
Consider also the quality of life.
It can be worth moving out of Sydney and living elsewhere and this can be the case even if you were to take a substantial haircut on your income.
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.
The executor of an estate has fiduciary duties to maximise the estate of the decreased. There can be conflicts of interest where someone is both executor and they apply, in their personal capacity, for the superannuation death benefits of the deceased, and this is because they are trying to avoid having the super death benefits paid into the estate, to benefit themselves.
Mum and Dad divorce many years ago, son dies without a will. Son has about $40k in assets plus about $400,000 in super death benefits. Under the intestacy laws where a person dies without a spouse and children then both parents will benefit equally from the estate.
The issue here is that $40k is in the estate and will go to each parent in the share of $20k each.
If the superfund pays the death benefits to the estate the parents will get another $200,000 each.
If the superfund pays the mum, dad will miss out on $200k and similar if the superfund pays dad.
But, by mum applying for the benefit herself she is depriving the estate the money which means she is potentially breaching her duties as executor. As executor she should be asking the superfund to pay the money into the estate – it is her legal duty to do so.
Moral of the story – seek legal advice before accepting the position of executor, especially if the deceased
This strategy is simple yet often overlooked.
Strategy: When buying a new main residence borrow 80% to acquire it, whether you need to or not.
Bart has $400,000 cash and wants to buy a new main residence for $500,000. He plans to borrow $100,000 and then later set up a LOC to invest.
He borrows $100,000 and settles on the purchase. Then he asks for a $100,000 LOC and the bank starts asking questions. Eventually, after giving a DNA sample Bart is approved, but they want a statement of advice from a financial planner saying that Bart will invest in shares.
Lisa is in the exact same situation. Lisa gets some credit and tax advice and borrows $400,000 to buy her main residence. At application stage she splits the loan appropriately so that at settlement she can pay down 2 loan splits and is left with one split with $100,000 outstanding.
In summary, Lisa has overcome the cash out restrictions and gotten a lower interest rate.
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