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what it means for CGT free for 6 years?

Discussion in 'Real Estate' started by WahMei, 18th Sep, 2012.

  1. WahMei

    WahMei Member

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    Hello,

    I have an investment house which has been renting for 3 years. Are you saying if I don't rent out or sell it before 6 years then I don't need to pay for the tax?

    If so, do I need to take it for own living for a certain period before selling in order to avoid paying tax?

    Thanks,
    WaiMei
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    The intention is that if you have a PPOR but then need to move out (eg, interstate transfer for work), you can keep the property as an IP for up to 6 years CGT free, just in case you need to move back in again.

    There are some rules though:

    - you can only ever have one CGT-free PPOR at a time. This means that if you move out of your PPOR and buy a new PPOR to live in, you have to nominate which of them gets the CGT-free status.

    - you have to have actually lived in a property as a PPOR before you can start to claim CGT-free status (ie you can't just buy an IP and claim it as a PPOR, you actually have to live in it).

    - There is no minimum-time specified by the ATO for how long you need to live there - but intent is important. If you live in a property for 3 months but then get transferred interstate for work, I don't think the ATO would have grounds for concern - it's pretty obvious why you moved out. However, if you buy something and live in it only to get the CGT-free status, you may need to justify your actions. Some accountants have suggested that living in a property for a minimum of 12 months should be sufficient - others are happier with less time. It depends on your circumstances and how far you want to push things.

    - you should have a professional valuation done on the property before and/or after it is used as a PPOR to determine the amount of CGT payable, if any.

    If you have never lived in the property, there is no CGT-free period. You have to pay CGT.

    If you move into a property which was rented out as an IP, you will still have to pay CGT when you sell on the increased value from when you bought it to when it became your PPOR.

    If you move out of a property which was your PPOR and rent it out as an IP and buy a new PPOR, you will need to pay CGT on the old PPOR when you sell it based on the increase in value from the time it stopped being your PPOR to the time you sell it.

    Also remember that an IP needs to be rented out (or available for rent), in order for you to claim deductions for expenses and/or interest. You can't just hold a property vacant for a period (there are exceptions).

    If it started life as an IP, you can't avoid paying CGT, but you will only have to pay tax for the period it was an IP - ie you pay CGT on the increase in value from the time of purchase to the time it became your PPOR.

    (notes: PPOR = Principal Place of Residence ... ie. where you live. The tax office refers to this as your Main Residence).
     
  3. WahMei

    WahMei Member

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    Thanks Sim!

    Another quick question about CGT amount. Have you got an idea how to calculate the Tax when the IP is sold if there is no CGT FREE?

    I was heard the tax rate will be calculated on the increased value which is divided by two then pro rata by the salary tax rate? Is it true?
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Basically, yes.

    You work out the difference between sales price (minus sales costs) and purchase price (plus purchase costs), add back any depreciation claimed (check with your accountant!), then assuming the property was held in personal names and thus 50% CGT discount applies, you divide the net gain amount in half.

    You then add this figure to your taxable income as if you had earned it as pay. This may or may not jump you up to a higher tax bracket, depending on the circumstances.

    For example, if your taxable income is $60,000 (32.5% tax rate), and the net discounted gain is $40,000 then your taxable income for the year is $100,000 which sees you up into the 37% tax bracket.
     
  5. WahMei

    WahMei Member

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    How about if that time has no income ie jobless or retired then the tax rate is based on only the net discounted gain i.e. $40,000?
     
  6. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Yes, if your personal taxable income is $0 ... you will pay tax on $40,000 in this example.
     
  7. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    ... if you know you are going to have a significant capital gain in one year, it makes sense to try and minimise your taxable income that year - for example, you can bring deductible expenses forward if possible (if you have another IP or investment loan, perhaps look into pre-paying interest in June for the following financial year) ... plus any other legitimate tax minimisation strategies.
     
  8. WahMei

    WahMei Member

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    Thank you so much for your detailed answer.:)
     
  9. Strawbs

    Strawbs Member

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    Great question WahMei and very detailed answers by Sim.

    Can you claim deprecation, interest and all the other standard deducations you would get on a (for what of a better word) standard investment property?
     
  10. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    As soon as it stops being available for rent, you can no longer claim any deductions at all - it's a private asset.

    If you have moved out of a PPOR and are renting it out (and claiming it CGT-free for up to 6 years), yes, you can claim everything that you would normally claim for an IP - provided it is rented out or available to be rented out.

    We did exactly this ourselves - purchased a PPOR in Adelaide and then 9 months later I got offered a job in Sydney, so we kept the property and rented it out as an IP, while we rented ourselves in Sydney. We then sold the property 6 years after moving out, CGT-free ... and for the 6 years it was an IP, we were able to claim all expenses (and of course declare all income!).
     
  11. Strawbs

    Strawbs Member

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    Thanks Sim.

    Our circumstances are pretty much identical. We own a house in Adelaide (our PPOR for a number of years) before I accepted a job interstate last year, we have kept the property and rented it out as an IP while we rented ourselves; so this is very timely post to come accross.

    Again thanks.
     
  12. WahMei

    WahMei Member

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    Hi Sim,

    Any idea how to get an IP return rate? ie what factors/ formula to determine the return rate?

    Was it a good IP is determined on 2 factors : rental rate and asset increased rate rather concerning the negative gearing?

    Thanks,
    WahMei
     
  13. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    You're welcome.

    Don't forget that you don't HAVE to sell the property after 6 years - you can keep it as an IP. You would then get it valued at the 6 mark and use that figure to calculate CGT when you eventually sell.

    Example:

    - Property purchased for $300,000 in 2004 and lived in as PPOR
    - You move out and rent 2 years later in 2006, renting the property out as an IP
    - 6 years later in 2012, you get the property valued at $500,000
    - 4 years later in 2017, you sell the property for $650,000

    The period from 2004 - 2012 is CGT-free, since it was your PPOR during this period. That works out to be $200K of gain tax-free!

    The period from 2012 - 2017 you need to pay CGT, so you work out the increase in value over that time ($150,000), then (ignoring purchase/sales costs and added back depreciation claimed to make the calculations easier), with the 50% CGT discount if held in personal names, your net capital gain is $75,000.

    If the property was jointly held by two people, you would each add $37,500 to your taxable income in the year of sale (2017).
     
  14. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    IP return rate depends on many factors. It all depends on how you want to calculate it.

    Rental rate doesn't really mean much at the end of the day - what ultimately matters is how much money you've made. If I've got a property returning 10% yield, but my costs are really high - I might still be losing money.

    It gets complicated when a property is negatively geared - since your cashflow return is negative and you won't actually know if you've made money until you revalue or sell in a few years time - you are relying on the capital growth to be higher than your holding costs.

    Positively geared properties can use measures such as Cash-on-Cash return, which is a measure of how quickly you get your initial capital back.

    For example: you put $20,000 of your own money into a $100,000 property which is giving $50 per week net income (after all expenses, including interest payments), then your Cash-on-Cash return is $50*52 weeks = $2,600 per year divided by $20,000 initial capital invested = 0.13 = 13% Cash on Cash return.

    You can interpret these percentages a different way: at 13% Cash on Cash return, you will get your money back in just under 8 years.

    The idea behind using CoC return is that your capital is the most important part of an investment - you want to protect it and ideally get it back out of the investment (without selling!) as quickly as possible so that you can re-invest it in a new investment and compound your returns.

    So, if it takes you 5 years to get your initial capital back, that's a 20% CoC return (you get 20% of your initial capital back each year for 5 years until you have 100% of your initial capital back and still own the asset).

    If it takes you 2 years to get your capital back, that's a 50% CoC return

    If it takes you 1 year, that's 100% CoC return

    If you get your capital back within 3 months, that's a 400% CoC return!!!

    Of course, this doesn't work with negatively geared properties ... and the whole equation gets infinitely more complicated when you start doing things such as borrowing against the equity in one IP to fund other investments and there is a mixture of cashflow and growth properties.

    It's also difficult with growth properties when you get periods of zero or negative growth - the property cycle is not linear, it goes in spurts, so you may have a property do nothing for 5 years but then double in value over 12 months. Ideally, you would pick your market and time it so that you get the doubling in value sooner rather than later - but that starts to enter the world of speculation, which is a different game again.

    In other words, there's no simple measure which suits every situation.

    Perhaps someone else might be able to offer some suggestions on how they calculate returns on their property portfolio?
     
  15. julya

    julya New Member

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    thax for information

    hi..
    Even I dont know about tax pay.. thax Sim for providing tax information..

    regards

    julya
     
  16. GregR

    GregR Reid Consultants

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    Sim has given good advice as usual.
    There is no such beast as a capital gains tax per say, there is a capital gain which you need to add to your other taxable income declared in that current year. If the assets had been held > 12 month, the capital gain can be discounted by 50% (or halved) when adding to your taxable income.

    It is always advisable to get a valuation of some sort, sworn or even a desktop like APM or Residex at each of the critical dates, when you moved out from it being an investment property, or wehen you moved in for an owner occupier. These will help substiantiate the capital gain calculations used.

    If you are going to sell an asset for which capital gains will be made, it always helps to sell early in the financial year. You may not need to then have to pay the resultant income tax until nearly 22 months later depending on your accountant and when they have to submit your tax return.

    Good luck
    Greg