All Topics / Legal & Accounting / Profits eaten by tax?

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  • Profile photo of MsTrumpMsTrump
    Participant
    @mstrump
    Join Date: 2008
    Post Count: 27

    Hi All,

    We've recently decided to commence our first property development project – knock the existing property on the land and create two new properties. Our main objective is to move into one of the properties and rent the other one out. After, say, a year (or however long we decide to keep the property for), we sell the PPOR and avoid CGT, keeping the profits for that one in our pockets. The second property, however, will eventually be liable for CGT, irrespective of when we decide to sell. I've spoken to my accountant regarding this and he's advised that the longer we live in that second property, the less CGT we'll pay later down the track when we decide to sell.

    My main concern is (and this may sound absurd to those who love to pay tax) is that any tax at all will need to be paid for the second property (which will initially be an IP), even though we'll eventually live in that one as well. Is there no other way of avoiding this CGT liability, and how do developers actually make the profits they do considering all the costs they're up for, not to mention tax at the end of the property's ownership period?

    Will both properties be up for CGT if we decide to sell both immediately after building? It's easy money for the ATO, and it's really demotivating for future developers…

    Thanks to all in advance!

    Profile photo of crjcrj
    Participant
    @crj
    Join Date: 2004
    Post Count: 618

    I'm assuming your accountant has suggested that any expenses on the second property once you are living in it ie not deductible eg rates, insurance, interest will be added to the cost base thus minimising your CGT

    Profile photo of MsTrumpMsTrump
    Participant
    @mstrump
    Join Date: 2008
    Post Count: 27

    Yes, he did suggest that – he spoke of increasing the cost base to minimise CGT, but my main frustration comes from the fact that any CGT is payable on the second property at all, even though we'll live in it after the first one is sold (it'll become a PPOR). Even renting out the property for a day will one day make it liable for CGT, which I think is completely ridiculous, as it's all to do with whether you rented it out firstly, or moved into it to begin with.

    Profile photo of Richard TaylorRichard Taylor
    Participant
    @qlds007
    Join Date: 2003
    Post Count: 12,024

    Developers dont pay CGT their income is classified as Trading Profit and therefore can write off all of their expenses against it.

    There are very few ways of reducing your Tax liability below 30% especially if the work is undertaken within a Company structure and a decent profit level is made. Trick is limiting it to 30% only by using retained earnings.

    Course if you look to buy and hold something for 366 days in say a SMSF the CGT liability is only 10% and this is what i like to do.

    Richard Taylor | Mortgage Broker helping investors build their wealth thru property
    http://www.mortgagecapitalaustralia.com.au
    Email Me

    0-40 Properties in a decade with an unencumbered value of over $35M. Email for a copy of my API article

    Profile photo of MsTrumpMsTrump
    Participant
    @mstrump
    Join Date: 2008
    Post Count: 27

    Richard, so even though I have a regular income from my job, can I not be classified as a developer, as in this instance development will clearly be happening? Obviously this will be for the purpose of completely eliminating the CGT liability. I plan on doing this more than once or twice, and don't wish to be hit with a CGT bill at the end of each project.

    I'm not sure if I'm understanding you correctly – does holding the property for more than 12 months decrease the CGT liability to 10%?

    Profile photo of crjcrj
    Participant
    @crj
    Join Date: 2004
    Post Count: 618

    Congratulations – as a developer you do not pay CGT, your profits get added on to your ordinary income and you pay tax at ordinary rates – no discount no matter how long you hold the property.  You've just eliminated your CGT completely.  Your intention is to be a developer so you are taxed as a developer

    10% CGT applies to capital gains in superannuation

    Profile photo of Dan42Dan42
    Member
    @dan42
    Join Date: 2008
    Post Count: 619

    Hi Ms Trump,

    Richard and crj are correct, if you are developing a property to sell, this income is treated as revenue, rather than a capital gain, and taxed at your marginal rate of tax.

    There is no way to avoid ALL the tax, but 70% of something is better than 100% of nothing.

    Profile photo of ducksterduckster
    Participant
    @duckster
    Join Date: 2004
    Post Count: 1,674

    I am reading an interesting book that talks about the timing of paying tax rather than not paying tax via different structures.
    see http://www.propertyupdate.com.au/pages/How-to-Legally-Reduce-Your-Tax….without-losing-any-money.html

    Profile photo of MsTrumpMsTrump
    Participant
    @mstrump
    Join Date: 2008
    Post Count: 27

    Thanks to all who have responded so far. Greatly appreciated, and will mention those things to my accountant when I see him again. The aim IS to sell both properties (eventually), but how would I be able to convince the tax department this was for revenue-raising and not capital gains purposes? More questions to consider, I suppose.

    Problem with being a developer is that I'm not. I have my regular day time job and earn my main income from there, so "officially" I'm not a developer – I don't earn my money from this as a full-time profession.

    Profile photo of crjcrj
    Participant
    @crj
    Join Date: 2004
    Post Count: 618

    I'm sure the taxation office will be happy to accept your declaration that you are a developer and tax you accordingly.  But, with respect I don't think you're grasping the point several of us are making.  Possibly if we use some figures it might be clearer.

    Let's say your development gives you a profit of $50K for each side – total $100K

    Non developer – moves into one side sells it later, no CGT assuming PPOR conditions are met.  Moves into the other side $50K profit, less 50% discount, taxable capital gain $25K, added to your other income that year so depending on your income you will pay tax of somewhere between $8500-$12000 less any reduction for being PPOR after you sold 1st side

    Developer sells one side $50K profit added on to other income – tax between $17-$25K
    Sells second side – similar result.

    So to save $12K you declare yourself as a developer and pay $34-$50K.  Still at least you're honest about your intentions.  The only reason you'd want to be classed as a developer is if your development loses money so you can claim the losses

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,213

    I don't really see what the problem is. You probably won't have to pay much tax anyway, and even if you do just think most businesses pay a lot more.

    You can only have one main residence – which is free from CGT. So if sell the first one tax free the second one will become tax free from when you move in. It will only be the period in which you had 2 that the 2nd will be taxed on. Long term this shouldn't be that much.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of MsTrumpMsTrump
    Participant
    @mstrump
    Join Date: 2008
    Post Count: 27

    Terryw, I can assure you businesses can afford to pay tax a lot more than what I can, and with their financial resources, they can probably afford better tax lawyers and accountants than what I can. Presuming their company structures, trust set-ups, and what not… they probably don't pay as much as what they theoretically should, anyway.

    My frustration stems from the fact the ATO will be getting something for nothing from me, without lifting a finger to develop the block of land we own or contributing to the process in any way. Despite the fact that we'll move into the second property eventually to decrease the CGT bill several years down the track, we'll still be liable for it, even though that property would've been our home for X amount of years.

    As I mentioned previously, I plan on doing this several times over, so I would prefer to buy, develop, build, and sell. I won't have the luxury of time on each property to live in in order to avoid CGT. Theoretically in that case, unless I find me a really good accountant, tax will be paid after each property is sold off.

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,213

    You want to enter into the business of developing, but don't want to pay tax? What makes you different to other businesses? 

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of TerrywTerryw
    Participant
    @terryw
    Join Date: 2001
    Post Count: 16,213

    Also, you will probably pay hardly any tax anyway – or maybe none at all. It is still worth minimising it as much as you can, but not a reason not to do it, or to give up.

    For some good info, i suggest you go to bantacs.com.au and look at the PDF booklets on developing and tax.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of MsTrumpMsTrump
    Participant
    @mstrump
    Join Date: 2008
    Post Count: 27

    Seriously – who actually wants to pay tax or maximise it? It's very demotivating. It's easy money for those who receive it.

    I'll follow your lead and advice and hopefully progress. Everyone has been helpful in this forum, so thank you!

    Profile photo of TerrywTerryw
    Participant
    @terryw
    Join Date: 2001
    Post Count: 16,213

    If you pay tax then you must be making a profit, so it can't be all bad.

    Don't worry about it too much. As they say only death and taxes are the certainties of life. 

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of Dan42Dan42
    Member
    @dan42
    Join Date: 2008
    Post Count: 619
    MsTrump wrote:

    My frustration stems from the fact the ATO will be getting something for nothing from me, without lifting a finger to develop the block of land we own or contributing to the process in any way.

    That is the same for every business. The ATO aren't on the checkout at Coles or delivering nespapers for the local newsagent, helping them run their businesses. If you go into development, you have to pay tax on your profits. There are ways to minimise the tax, like you have mentioned, by moving into one and then selling and moving into the other, but you can't eliminate the tax entirely.

    If you make a profit on the first house, it is tax free, due to the main residence exemption. When you sell the second one, you pay tax on half (if held over 12 months). IT is then further reduced by the time you lived in this house. If you lived in it for two years, you only pay tax on 1/2 x 33%, or 16.67%. If you make a $75,000 profit on this house, $62,500 of that gain is TAX FREE.

    So you get the whole gain on the first house TAX FREE, and 5/6 of the second house gain (if you live in it for two years) TAX FREE.

    Who would complain about paying such a small rate of tax?

    Profile photo of KennyjaizKennyjaiz
    Member
    @kennyjaiz
    Join Date: 2009
    Post Count: 69

    MsTrump,

    I don’t think I will need to get into any technical info of tax as other people on the forum has done a fantastic job. I understand you are frustrated by the fact that your potential profit maybe reduced by tax implications. However, there is no need to convince you that people are happy to pay taxes – it is a necessarily evil and an obligation in return for the privileges we get from living in this country. Whether or not you think the government is efficient in spending our money – or if it is fair – is irrelevant. Unless of course, you are lobbying to get the tax law changed.

    The fact of the matter is, when you undertake an activity to generate income and as long as it satisfy Div 6 of ITAA, you are required to pay tax. There is no difference between you trading real estates and a single mum running a home business making hand-made jewelleries. The ATO does not interfere or help any business owner or employee in their day to day work.

    There are ways to minimise tax, but no way of completely avoiding it if you choose to be a tax resident of this country (you pay GST when you buy groceries). However, take comfort in knowing that you only pay income tax when you have made money. Whether or not it’s worthwhile is up to you to assess.

    The logical thing to do now, is investigate what are the tax implication if you intend to develop on a regular basis and under what structure. You may find tax advoidance is not the way to make money.

    Good luck with the development
    Kenny

    Profile photo of never too latenever too late
    Member
    @never-too-late
    Join Date: 2009
    Post Count: 18

    Ms Trump,

    Still only learning myself, but might it be more profit rewarding to demolish, build one,( PPOR), live in it while the other is being built (over a 12 month period), meeting criteria for exempion of CGT living in it for the 12 months required before selling.  Hence, no rental income in that first 12 months but then probably lots of tax deductions in that first year.  Have the second completed and ready to move into when the first one (PPOR) is being settled. Thus keeping all profit on the sale of the PPOR and then live in No 2 for twelve months and avoid CGT again, second time . Or couldn't it work like that.?
     
    I thought it to be feesible but not sure about the expenses claim for No 2 in the first financial years assesment, or taking into consideration the undoubtable extra cost to the builder to come back twice< It could be worked>
    . You would have to do the sums with lost revenue but saved tax and intrest. Maybe only paying tax on bank savings intrest on what you have saved from holding off building the second for the first year.  If you are spending it on the second ,you in turn declare less bank interest.  Could be way off, but just a new spin.

    Profile photo of never too latenever too late
    Member
    @never-too-late
    Join Date: 2009
    Post Count: 18

    Ms Trump,

    Still only learning myself, but might it be more profit rewarding to demolish, build one,( PPOR), live in it while the other is being built (over a 12 month period), meeting criteria for exempion of CGT living in No 1 for the12 months required before selling. 

     Hence, no rental income in that first 12 months but then probably lots of tax deductions in that first year.  Have the second completed and ready to move into when the first one (PPOR) is being settled. Thus keeping all profit on the sale of the PPOR and then live in No 2 for twelve months and avoid CGT again, second time,whilst banking the profit of the 1st (PPOR)  Or couldn't it work like that.?
     
    I thought it to be feesible but not sure about the expenses claim for No 2 in the first financial years assesment or taking into consideration the undoubtable extra cost to the builder to come back twice< It could be worked>

    . You would have to do the sums with lost revenue but saved tax, and intrest. Maybe only paying tax on bank savings intrest on what you have saved from holding off building the second for the first year.  If you are spending it on the second you in turn declare less bank interest.  Could be way off, but just a new spin.

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