Given Australians’ love of property, professional planners at times will have to factor into tax and retirement planning advice how clients can deal with the capital gains tax implications of selling real estate.
In some cases, clients can have properties that have had several uses. Examples include:
- A property used first as a home then to produce rental income when a new home is purchased
- A property originally used as a home and then a portion of it is used to produce income, such as when the owners start a home-based business
- A property is originally purchased for rental purposes and then becomes a home
- A property is purchased as a home and the owners move out, do not purchase another home, and rent the property.
There are two methods that apply when calculating how much CGT is payable when a property is used as both a residence and to produce income. The first method calculates the taxable gain based on the increase in the value of the property after its use has changed. The second method calculates the taxable gain based on the days of ownership.
Where a property starts out as a residence and then becomes a rental property after August 20, 1996, the valuation method must be used. In this situation, the taxpayer is deemed to have acquired the property at its market value when the change of use occurs.
Under the valuation method, CGT is payable, when the property is disposed of, on the amount that the net sale proceeds exceed the market value when it commenced producing income. It is, therefore, important if you have clients in this situation that you recommend that they engage the services of a valuer experienced in valuing properties for CGT purposes.
In what can only be described as an interpretation of the law that maximises tax revenue, if a property becomes a rental property and is sold in less than 12 months, the Australian Taxation Office states the taxpayer cannot get the benefit of the 50 per cent general discount. This will be the case even if the property had been owned for many years while being used as a residence.
When a property is first used as a rental property, and then becomes a person’s residence, you must use the days of ownership method. Under this method, the number of days the property was used for rental purposes, expressed as a percentage of the total days of ownership, is the period that becomes assessable for CGT purposes.
An example of this would be a property that was rented for five years, and then used as a residence for five years; half of any gain made when it is disposed will be assessable for CGT purposes.
Another situation is when vacant land or a holiday home has been owned and is a major financial asset for the clients. If the property was purchased prior to September 1985, there are no CGT implications. However, if the property was purchased after the CGT system commenced, it will be important to establish the cost base of the property over the entire ownership period.
The costs included in the cost base of the property include not only the original purchase price, stamp duty and legal costs associated with the purchase, but also all of the holding costs, such as council rates, interest on loans to purchase the property, repairs and maintenance costs, and any other expenses associated with maintaining the property or improving it.
