Why it’s important to consider which property is your “home” | CASE STUDY

Did you know that only 300,000 or so people own two investment properties in Australia?

The number who own three or more falls dramatically from the figure.

However, more and more people are taking charge of their financial futures by buying investment-grade real estate assets.

Like so many things with wealth creation, though, there are tax implications when a person improves their financial lot in life.

The tax department rarely misses its chance to get a slice of the profit pie!

One of these is when it comes to Capital Gains Tax (CGT) which usually needs to be paid on the sale of an investment property.

As you probably know, your principal place of residence is CGT-free, but sometimes it’s best to consider a different property to be classified as the place that you call home.

Let me explain further…

Taxing problem

Leah came to see us at Metropole Wealth Advisory for advice on which structure to set up to operate a new business venture.

However, during this review, we identified that she was in the process of selling her family home at a loss as well as constructing a new home on land she had purchased two years previously.

The problem was that the loss on the home was not classed as a capital loss that could be used to offset any future capital gains.

Plus, because she bought the land for her new home two years before starting to build her new home, it would have a period when it would be classified as an investment.

That would mean that any future capital gains would also have a taxable proportion.

Timing issues

As you can see, there was a two-year overlap between the ownership period of the home and the land that would eventually be the site of her new home.

The expected capital loss on Leah’s current home was more than $100,000, but the increased vacant land value in the two years was about $150,000.

Fundamentally, this meant that Leah could not use the $100,000 capital loss against the capital gains she had recently made on what was, for all intents and purposes, investment property for that period or to offset any other capital gains.

Likewise, the $150,000 increase in the land value would one day be proportionally taxed, with the expected taxes, depending on timing, amounting to more than $50,000.

Remembering, of course, that the main residence exemption for CGT has capital gains taxed at zero if you move into the property as soon as practicable.

However, the legislation does not allow for a capital loss on a home to be used to offset any capital gains.

What the legislation does do, however, is allow a taxpayer to nominate which property to use for tax purposes if more than one is owned concurrently.

Further, it also allows a construction period on a home to be counted towards occupancy.

Lesson learned

Fortunately, Leah had come to see us, albeit originally for a different purpose, because we were able to reduce her looming taxation burden.

We did this by organising a valuation on her current home that was in line with the expected sale price.

We also advised Leah that if she chose the second property as her home for taxation purposes then the capital loss on the existing property would be allowable and could be used to help offset her capital gains.

This, in turn, allowed the land and new construction to be identified as her home for tax purposes, which meant the $150,000 market value gain wouldn’t be taxed as it would’ve been done if still classed as an investment property.

Fundamentally, the identification of the existing property as an investment property for two years allowed the vacant land and construction period to all be eligible from the date of purchase for the CGT main residence exemption.

This resulted in an immediate tax benefit of about $25,000 as well as the potential to have up to a further $150,000 as a non-taxable capital gain if the new home was ever sold.

Issues like Leah’s are why it’s so important to seek out professional advisors who have experience in multiple disciplines.

In most cases, there are a number of considerations that will need to be managed such as this one, which involved Metropole Wealth Advisory identifying an alternate taxation strategy that legally allowed a capital loss to be used as well as a reduction of a potential tax on the new home if it was ever sold.

About Ken Raiss Ken is director of Metropole Wealth Advisory and gives strategic expert advice to property investors, professionals and business owners. He is in a unique position to blend his skills of accounting, wealth advisory, property investing, financial planning and small business. View his articles