Australians who have ever thought of renovating an old property and on-selling it to make a quick profit might soon face a whopping 47% tax.
The idea, also known as ‘flipping’ has been made popular by TV reality shows like The Block is a popular but risky strategy with the goal of making improvements to a property which translates significantly up-sizing your bottom line.
Many property flipping seminars suggest you aim for a renovation outlay of around $2 for every $1 spent, for example.
And while I’ve already seen many house-flipping strategies flop, a new proposed tax could make the strategy even riskier.
An Administrative Appeals Tribunal (AAT) has now suggested that property renovators and ‘flippers’ are taxed at their highest marginal rate of up to 47% when they come to sell.
It would mean losing their 50% capital gains tax (CGT) discount effective even if they hold the property for 12 months or more, the lawyers added, which originally saw property flippers only pay tax on half of their net capital gain.
Generally, a taxpayer’s main residence is CGT-free for tax residents if the property is the main residence throughout the ownership period.
So essentially, property investors selling any property that could be regarded as a commercial transaction would lose out on the CGT discount.
The decision – which is being reviewed by the Australian Taxation Office (ATO) – could affect the tax treatment of a range of property investments – such as subdividing properties for development or “flipping”.
It could also have huge implications for Australia’s multi-billion-dollar renovation industry, which has been turbocharged by the prospect of big profits from quick property turnarounds, the AFR reports.
The ATO is also challenging tax exemptions where long-term property owners, such as farmers, decide to sell their land for commercial or residential development.
Why is CGT now under scrutiny for property renovators and ‘flippers’?
The popular CGT discount is under challenge after an AAT ruling allowed an 86-year-old self-funded retiree to offset losses on the sale of her downsizer apartment against other income because it was considered to be a commercial transaction.
Sydney-based Jenifer Bowerman successfully had losses on her downsizer apartment offset against other income because it was purchased with the intention of selling it for a profit.
In 2015, she bought an off-the-plan apartment in a complex at Foreshore Boulevard, Woolooware Bay, about 20km from Sydney’s CBD, for about $1.5 million.
Two years later she purchased another in Dune Walk at the same complex for $1.2 million where she intended to live until the first apartment was completed.
The tribunal was told Bowerman expected to sell Dune Walk and move into Foreshore Boulevard after the sale of her main residence, and that she had sold her family home to fund the deals.
She sold Dune Walk in early April 2020 at a loss of $185,000 because property prices had dropped during COVID-19.
AAT senior member Gina Lazanas found the sale of Dune Walk was tax-deductible under 8-1(1) of the Income Tax Assessment Act 1997, which allows an individual to deduct a loss or outgoing “if it incurred in gaining or producing assessable income”.
So, what is a flipping house strategy?
Proponents of this strategy, and those who sell courses teaching how to do this, will tell you that the key to flipping houses successfully is knowing the types of improvement you should make to the property to maximise your bottom line.
In order to achieve such lofty profits, you are usually taught to undertake a lot of due diligence by researching local property values and ceiling prices to ensure the strategy is worthwhile.
You would also need to consider costs and potential profit margins, the market itself and the type of target property.
Generally, a strategy for flipping houses would look something like this:
- Cut costs where you can: Most people borrow against their home and then use the equity to fund their house flipping plans meaning you don’t need to apply for a new loan.
- Do renovations that add the most value: Cosmetic work (such as painting, which is low cost, kitchen renovation, bathroom renovation, and extensions are generally thought to be the works that add the most value.
- Pay directly for tradesmen rather than paying a contract builder: Hiring tradesmen directly will make the renovation cheaper, or even better, do the work yourself.
- Buy low and sell high: This means you not only have to identify the potential in a property but you need the negotiation skills to buy below market value. This is easier said than done. Especially in the current property market.
Сan house flipping work?
While this strategy might make a few experienced property investors money, in my opinion, it’s the wrong strategy to adopt for two reasons:
- To improve a property's value by $2 for every $1 you spend on it you need to do much more than the simple cosmetic renovations – the type which is in the scope of most D.I.Y’ers. It generally involves structural renovations that cost significantly more, take more time, require permits and involve a different level of expertise.
- And even if you can undertake this type of work… Most of your profits will be eaten up in costs.
Add in the potential 47% tax surcharge and property investors looking to flip property quickly could almost certainly be in the red financially.
A final thought for investors…
The reality is that property investors risk losing substantial chunks of their investment profit when flipping houses, even if a CGT exemption still applies.
If you manage to have any profit left over, the taxman will take a substantial share.
Rather than dabbling in the high-risk flip type of project, I would recommend investors buy, renovate and hold on to their properties.
You see… rather than selling you can release your newly manufactured equity by refinancing your property.
By doing so, you will not only retain all of your post-renovation profit, but you’ve retained that great newly renovated investment property, which should attract a wider range of tenants, command a higher rent, and give you the benefit of depreciation allowances.
That’s what smart renovators do!
