Forums / Property Investing / Creative Investing / Capital Gain Tax reduction on a lease-option deal

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  • Profile photo of CrisCris
    Participant
    @cristineyang
    Join Date: 2016
    Post Count: 10

    Hi all

    I have heard about if structuring a lease-option deal right, the capital gain tax can be reduced sometimes to zero, is that true?
    Here is my understanding of how this capital Gain Tax reduction works, and anyone who is experienced in the lease-option deal pls comment or correct me if i am wrong, thanks a million.

    Supposed there is a seller of a house value at $400K, and he bought it cheap 5 years ago around $300K, if he sell it to me at $400K then the capital gain subject to Tax would be $100K (by the way, even if so, how much tax exactly he will have to pay here?)

    ok, now sold to me at $400K on a 5 year lease with the option to buy, my monthly payment would be $500, so at the end of month 60 (year 5) the end sale price would be $400,000 – 60 x $500 = $400,000 – $30,000 = $370,000

    So in this case, is the seller’s Capital Gain which subject to Tax now being reduced to $370,000 – $300,000 = $70,000

    (how much capital gain tax exactly the seller has to pay now after 5 years? )

    My understanding is even after 5 years, and the capital gain has minus the monthly rent but it seemed the seller still have to pay a big Capital Gain Tax bill. Is there a way (e.g structure the deal differently?) to reduce the CGT even further so that it will be more appealing to the seller?

    Any advice or comments or corrections welcome and i am eager to learn.

    Thanks a million

    Cris

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,325

    Hi Cris,
    Keep in mind that many times the seller may not need to pay ANY CGT. Main one is if they are selling you their PPOR. It is probably important that you know just how a sale affects the seller, so you can create a deal that they can say “Yes” to, eh?

    Then, as you say, there may be other ways to assist – e.g. if you are paying Rent for 5 years, then that could perhaps be treated differently to a Deposit payment (or, would it?). Now, I don’t know of just what can/can’t work, but it could be that there will be a different treatment of monies on an ordinary sale when compared to a Lease Option sale.

    Perhaps check some of these with the POAA crew – here http://www.poaa.asn.au/ If I have it right, many of those in that group are using alternate methods of selling/renting properties. Some are around as members on here – maybe one of them will stop by to offer you some ideas.

    Re CGT and its calculation, you are right in that the total profit is taxed appropriately depending on the seller, and will often be less than 25% of the total profit gained (based on the 50% discount if owned longer than 12 months, and then taxed at the seller’s Marginal Tax Rate). So, the amount paid could be quite different for each seller.

    Good luck with your hunting down of the information you need,

    Benny

    Profile photo of CrisCris
    Participant
    @cristineyang
    Join Date: 2016
    Post Count: 10

    Hi Cris, Keep in mind that many times the seller may not need to pay ANY CGT. Main one is if they are selling you their PPOR. It is probably important that you know just how a sale affects the seller, so you can create a deal that they can say “Yes” to, eh?

    Hi Benny

    thanks for the information and the tips! btw, what is PPOR mentioned above means? sorry if it is a basic question as i m new to these things… And how does this PPOR works exactly to keep the seller not paying ANY CGT?

    Re CGT and its calculation, you are right in that the total profit is taxed appropriately depending on the seller, and will often be less than 25% of the total profit gained (based on the 50% discount if owned longer than 12 months, and then taxed at the seller’s Marginal Tax Rate). So, the amount paid could be quite different for each seller.
    Good luck with your hunting down of the information you need,
    Benny

    Then my next question here is, the calculation of CGT.

    R u saying with my example above, the actual CGT that the seller will be paying after 5 years lease finished if i end up buying the property at $400K (the initial cost of the property is $300K for the seller), and if my monthly rent is $500.

    he will be paying CGT of:

    $400K-$300K – $500 x 60 months = $70,000 (subject to CGT of 12.5%, as 50% discount of CGT after 12 months, and initial CGT is 25% of capital gain)

    So $70,000 x 12.5% = $8,750 will be paid as CGT in this case?

    is my caculation correct ? pls correct me if any number is wrong here… I need numbers to throughly understand ur theory…

    thanks heaps Benny

    Cris

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,325

    Hi Cris,
    PPOR = Principal Place of Residence = their own home (or once was – conditions apply).

    and Cris, I am not sure how you got this :-

    and initial CGT is 25% of capital gain

    …so let me give you an example of CGT that I am reasonably sure will be somewhat correct (as I am unfamiliar with Lease/Options and payments being Rent, or not, I will leave that part out). Here is a simple CGT calculation:-

    Using some of your numbers :-
    Cost Base = Vendor purchase price + purchase costs ($20k) + any renovation costs (let’s say $0) = $300k +$20k = $320k

    Sale Price = $400k – selling costs ($10k) = $390k

    Capital Gain = Sale Price – Cost Base = 390 – 320 = $70k

    Thus, working out Capital Gain Tax assuming the seller owned the place longer than 12 months, and assuming it was NOT his PPOR is like this:-

    Taxable Gain = CG of $70k x 50% x Marginal Tax Rate = $35k x Marginal Tax Rate. So, HOW do we calculate Marginal Tax? Something like this…. If seller earns $40k per annum (and currently pays Tax on that amount of $3670), then the $35k is added to his Income for that year to total $75k, then taxed for the year at the appropriate marginal rate to pay a total of $12,300 (this from the personal tax rates for 2015/16).

    Now, subtract the tax they WOULD have paid if no sale had occurred ($12,300 less $3670) = $9k approximately.

    Note that I DIDN’T add in any Levies (Medicare, etc) so some small differences would come into it. But that should give you a better idea of how CGT is calculated – it is not overly straight forward, but also not impossible to understand…..

    Now, I don’t quite understand that first phrase of yours (the one I highlighted) but your calculation of CGT came out remarkably close to mine. So maybe your guess was pretty good, or maybe you DO understand it and had used what made sense to you to arrive at the right answer. Well done…. ;)

    Benny

    PS For anyone reading, I am not an accountant or other licenced adviser – so the above is all how “I think it works”. I could be wrong !! Get proper advice rather than depending on the above…..

    Profile photo of CrisCris
    Participant
    @cristineyang
    Join Date: 2016
    Post Count: 10

    hi Benny

    Thx a lot for your comprehensive answer. for my calculation of the CGT i think i made it wrong of the initial 25% as CGT. however of the number of come out right partly is due to the coincidence lol.yep thanks for the tip of the PPOR :)

    Cris

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