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Cutting off the backyard, building a house on it and then selling
has implications. If you bought the property as your home and
many years later sectioned off the backyard to sell it, then you’ll get
the 50 per cent CGT discount and not have to charge goods and
services tax (GST) unless you’re already in the property developing
business. If you take this a step further and build a house, then
you’re doing more than merely realising an asset, you’ve crossed
the line into being in business. With this in mind, the profit from
the time the property is committed to the development will be
taxed as normal income with no 50 per cent CGT discount and
you’ll have to pay GST. I’ve seen this erode the profit to well below
what would’ve been made on the sale of the vacant land.
Not having dinner often enough with granny can be a mistake.
Even if you’re not receiving rent from a granny flat in your
backyard, it could be considered a separate dwelling and not
protected by your main residence exemption if it’s not used as an
extension of your own home, reference Tax Determination 1999/69.
Be careful about taking advice from the person selling you the
property rather than your accountant. Remember the accountant
isn’t getting a kickback off the developer. Of course, they’re going
to have to charge you for their time but that’ll be a fraction of the
amount of money you’re about to spend. It’ll also be tax deductible
and probably less than your building inspection report.
Replacing all of the kitchen rather than just repairing the part
that’s worn is an issue. An example of doing it the right way
would be leaving the cupboards intact, but replacing the doors
and the bench on top. Using similar materials, this would qualify
for a full deduction as a repair. If you replace the whole lot, it’s
a replacement in its entirety so you’ll only be entitled to deduct
annual depreciation of 2.5 per cent of the cost over 40 years.
Deciding to sell the property, but not undertaking repairs before
the end of the financial year that the last tenant moved out, will
mean you miss out on claiming a deduction for these repairs.
If the property is only being held for resale in the financial year
the repair costs are incurred, then they’ll only increase the cost
base for CGT purposes. So get in quickly, you’re considered to
have incurred the expense once you’ve instructed the repairer to
Thinking you need a rental property so you can reduce your tax
bill can be a false economy. Your tax is reduced because the
ATO accepts that your property is costing you more than it’s
bringing in. The ATO will only give you back a portion of that loss
depending on your tax rate. Eventually you need to see enough
capital growth to recoup your real loss, plus buying and selling
costs. Accordingly, the property has to stack up as an investment
before the tax advantages are even considered.
Pre-paying interest without telling the bank will mean it will
simply treat it as a principal repayment. You won’t be able to
claim a tax deduction and if you take your money back out of the
loan, it’ll be considered a borrowing for private purposes.
Your home is exposed to CGT if you take in flatmates who pay
more than just their share of the costs that increase because
they’re there. For example, electricity will increase but the
interest payments on the loan won’t. Section 118-145 of the
ITAA, the ‘six-year’ absence rule, won’t help because you’re still
living there. The income you receive is taxable but you’re entitled
to deductions for a percentage of the property’s expenses. The
percentage is determined by how much use the tenant has of
the property. Generally this would be 50 per cent as you probably
have a room each and share the rest of the house, reference
Income Tax ruling 2167. This also means that only half your house
will be covered by your main residence exemption and your cost
base will be reset to the market value of the property when it first
earns income, (section 118-192 of the ITAA).
Not leaving your heirs the records they need to calculate the
capital gains on properties they inherit is another blooper. Unless
the property is pre-1985 or is your home at the date of your death
then your heirs, when they sell, will pay CGT on the gains during
both your period of ownership and theirs.
If you’re a young investor, don’t just follow the traditional
investment strategies of the middle-aged. In many cases, you
need to do the opposite. For example, if you buy a negatively
geared property in your name for the tax benefits, by the time
you’re in a decent tax bracket it’ll probably be positively geared.
Make sure you buy next month’s Australian Property Investor
for another 15 must-know tax tips and traps for the unwary. API
The joy of flatmates
Heirs and CGT
Buying for your generation
Subdividing your home
The wrong advice
Missing the financial cut-offs
Investing for the wrong reasons
Repairs versus replacements
Registered tax agent, CPA, chartered accountant and founder
of BAN TACS Accountants Pty Ltd, www.bantacs.com.au
This information is of a general nature only and does not constitute professional advice.
You must seek professional advice in relation to your particular circumstances before
acting. This information is also to be read subject to the disclaimer on page 6.
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