Questions And Answers

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Last Updated: Monday 4th July, 2005

Capital Gains Tax

Deceased's Home
Question –
You have stated in previous articles that a deceased’s home remains exempt from CGT if it is occupied by a child of the deceased who will eventually inherit it. What is your authority on this and how does this apply if there is more than one child that will inherit yet only one child lives in the house.
Answer –
The relevant section is ITAA 1997 118-195 (1) item (c) in column 3 in the table at the end of that subsection. To paraphrase this disjointed piece of legislation, it says:
Regarding a dwelling acquired from a decease estate a capital gain will be disregarded if you are an individual and the interest in dwelling and the interest passed to you as a beneficiary of the deceased estate and the dwelling was from the deceased death until you sold it was transferred in to your name your own home.
Therefore if you bought out your siblings when transferring the home to your name there will be a CGT liability for them from the time of their parent’s death until the property was sold to you. That is unless they property was transferred within 2 years of the parent’s death as in this case another concession applies. So lets assume you have two siblings and you all share equally in the home and the home was transferred to you at a date later than 2 years after your parent dies. Each of your siblings will be up for CGT on 1/3 of the increase in value from the date of your parent’s death and the market value on transfer.


Home Owned in Common with Deceased
Question –
Referring to your article-Smart Money. My wife & I purchased a home 3 years ago with my wife's parents. It was a dual living arrangement with 60% our share & 40% parents. Both parents passed away within 18 months & left us as life tenants with the 40% estate to be divided up between family members when the house was sold. It will be 2 years this december since my father-in-law passed away. Will the estate have to pay C.G.T. on any capital gains on the 40% share after December or are we exempt? Can you clarify or do we need to discuss this with our accountant??Thank you.

Answer –
The estate will not have to pay any CGT until the property is sold, if it is sold later than 2 years after death. If you buy the property off the estate and have lived there the whole time, at least the portion you receive as your inheritance won't be subject to CGT. There are problems with life tenancies, surrendering your life tenant rights is a CGT event in itself. I recommend you send the ATO a copy of the will and details of what you intend to do with the house and ask them for a ruling as to what is the cost based and deemed market value received of the life tenancy.


Rental Property Questions

Loans
Question –
We are unsure if our loan/banking accounts are properly structured from a tax savings point of view.
In order to purchase 3 rental properties we changed our home loan to a Line of Credit (LOC) under this LOC we set up a separate interest only loan for each property. All our income is regularly paid into the LOC and we draw on it to pay our normal household expenses. As the equity in our own home increased we increased the limit on each property’s separate interest only loan and drew those funds back to the LOC which. The only money ever borrowed from the LOC was for our own home and the regular draw downs for our living expenses but as all our properties were security on our borrowings we could only increase the interest only loans by reducing the available credit in the line of credit or having the properties re-valued to access our increased equity. Now we have paid off our home we were considering paying our income into the loans on the rental properties and redrawing when we have to pay our living expenses.
Answer –
You were doing just fine at the start having the rental property loans interest only and only putting your income and withdrawing your living expenses from your own home loan. Traditionally, interest is claimable only on a loan where the actual money borrowed is used directly to produce income i.e. buy the income producing property. If you increase the amount of the loan later, then that portion of the loan is linked to whatever the new funds borrowed are used for. In your case it was to pay off your private living expenses and your remaining home loan. Accordingly only a percentage of the rental property interest only loan is now deductible and you haven’t really paid off your home at all.
Based on the principle that the interest on a loan is tax deductible if the money was borrowed for income producing purposes, once you start to put your income into one of the rental loans and draw your living expenses from it, that loan will become non-deductible within around 5 years. Even if you still owe the original amount.
For example: A $100,000 loan used solely to purchase a rental property is financed as a line of credit. To pay the loan off sooner the borrower deposits his or her monthly pay of $2,000 into the loan account and lives off his or her credit card which has up to 55 days interest-free on purchases. The Commissioner now considers there to be $98,000 owing on the rental property. In say 45 days when the borrower withdraws $1,000 to pay off his or her credit card the loan will be for $99,000. However, as the extra $1,000 was borrowed to pay a private expense, viz the credit card, now 1/99 or 1% of the interest is not tax deductible.
The next time the borrower puts his or her $2,000 pay packet into the account the Commissioner deems it to be paying only 1/99 off the non-deductible portion i.e. at this point there is $96,020 owing on the house and $980 owing for non-deductible purposes. When, 45 days later, the borrower takes another $1,000 out to pay the credit card, there will $96,020 owing on the house and $1,980 owing for non-deductible purposes so now only 98% of the loan is deductible, etc, etc.
In addition to the loss of deductibility, the accounting fees for calculating the percentage deductible could be high if there are frequent transactions to the account. The ATO has released TR2000/2 which confirms this.
To ensure deductibility and maximise the benefits provided by a line of credit you will need an offset account that provides you with $ for $ credit. These are two separate accounts – one a loan and the other a cheque or savings account. Whenever the bank charges you interest on the amount outstanding on your loan they look at the whole amount you owe the bank i.e. your loan less any funds in the savings or cheque account.
Lines of Credit are dangerous even if you are careful and keep your own drawings to the loan for your home you may one day regret this still because you may decide to rent it out and the nexus of the loan to the house would have been lost by all the churning of the LOC. An offset account provides exactly the same interest savings without the mess.

What to do now? Get your accountant to work out, based on the example above, how much of the loans continue to have a link to the original purchase of the rental properties. Then set up a completely new loan for the whole amount you owe the bank. The new loan should have four splits 3 interest only loans for the portion that belongs to each rental property and a principle and interest loan for the portion your accountant calculates as private. Attach an offset account to the P&I loan where you can deposit all your income and withdraw all your living expenses. Once you have organised all of these loan facilities get the bank to draw on all these facilities at the one time and directly (without going through your personal accounts) pay off your old loans all at once. Do not deviate from the above without contacting me as each step is important. For example you must clearly pay out the old loans not just re arrange them.

Developing Rental Properties
Question –
I am looking at developing an existing IP, cutting off the old existing front house from the rest of the lot & building 2 townhouses at the remaining land. I intend to keep the 2 townhouses If I decided to sell off the existing front house how would CGT be calculated?? & would GST be payable??


Answer –
MT 2004/D3 covers everything you need to know about the GST side but I think it is about 93 pages long. Our booklet How not to be a developer? This is only 14 pages long and has a section on GST. In the meantime: The GST definition of enterprise is wider than the income tax definition of being in business. So you could be only subject to CGT on the sale proceeds yet have to charge GST as stated in paragraph 153 of MT2004/D3. MT2004/D3 at paragraph 187 says "that the realisation of an investment does not amount to trade (enterprise). But paragraph 170 says that a one off transaction that has a business like nature would be caught.
The sale of a new or substantially renovated property will be suject to GST even if used as a rental for less than 5 years Section 40-65. But this is only the case if you are registered for GST. If you are not registered and the property was used as a rental its sale is not part of your normal turnover so your GST turnover should not exceed $50,000 therefore the sale will not force you to be registered.
Basically if you use all the properties as a domestic rentals. Did not buy them with the intention of resale at a profit and are not registered for GST you only have to worry about the CGT ramifications of the sale.


Constructing A Rental Property:

Question –
I purchased land in 2004/05 constructed a house which was not completed by 30th June, 2005. I intend to use the house as a rental property as soon as it is finished. Can I calim the interest, borrowing costs and rates as a deduction in 2004/05.
Answer –
Yes, reference Steel's Case. But the borrowing costs must be amortised over 5 years.


Salary Sacrifice and Fringe Benefits Questions

Salary Sacrificing Laptops
Question –
If I use your double dip strategy and claim a tax deduction for the depreciation in my personal tax return for a laptop salary sacrificed from my employer, what happens when I sell it? If 12 months have past do I get the 50% CGT discount on the difference between what it has been depreciated to and the price I receive for it.

Answer -
CGT does not apply to the sale of plant and equipment. The difference between the written down value and the money you receive for it is either normal income or a work related deduction assuming you are using it 100% for business. Otherwise apportion on the percentage of business use.


Salary Sacrificing Superannuaion
Question –
      I have been told that even with the surcharge I am better off salary sacrificing into superannuation than taking the amount as wages. Yet my calculations show this not really to be the case infact for a whole $15,281 contribution to superannuation I am not much better off yet the money is tied up until I am at least 55 years of age.

Answer –
      The example this reader provided was using 2004 taxable figures so there is a difference today but the principle is the same. In his example he reduced his taxable income from $47,308 to $32,027 by sacrificing an extra $15,281 into superannuation. The trouble was that he had already contributed so much into super he was liable for the surcharge because the threshold adds superannuation contributions, wages, fringe benefits etc together to calcualte the threshold. Moving money from wages to super does not reduce the amount tested against the threshold. But, due to such high superannuatiion contributions his tax bracket was so low that he was only in the 31.5% tax bracket on his wages. With the tax on super of 15% and the surcharge of 7.61% he was going to lose 22.61% on the money put into super anyway.

             |    Example at 31.5%         |    Example at 48.5%         
Taxable Income   |     47,308      32,027   |     75,000      59,719      
Income Tax   |     10,302.02        6,260.50   |     23,182.00      15,909.76      
Super Contrib.   |     57,692      72,973   |     30,000      45,281      
ATI      |    105,000     105,000   |    105,000     105,000      
15% super`   |       8,653.80      10,945.95   |       4,500        6,792.15      
Surcharge 7.61%`   |       4,390.36        5,553.25   |       2,283        3,445.88      
Total Tax   |     23,349.18      22,759.70   |     29,965      26,147.79      

Difference for putting $15,281 into super
       589.48        3,817.21    

    The moral of the story is there is no point in putting so much money into super that your marginal tax rate becomes the same as the super plus surcharge tax rate.

Minor Benefits and Christmas Parties
Question –
If I only give my employees a minor benefit (less than $100) now and again and a Christmas party at the end of the year, I don’t have to pay FBT. Do I?

Answer –
Irregular, infrequent and minor (under $100) benefits to employees are exempt from FBT. Watch out for the Christmas Party. If there is entertainment the cost can be under $125 per employee but that is for the total benefit to the employee and his or her family and any presents given to them at the party. Further a Christmas Party, whether there is entertainment or not, is considered "entertainment" for tax purposes so the cost of the party is not tax deductible to the employer. Fringe benefits, even if they are "entertainment", are tax deductible to the employer. If the party is not tax deductible the employer will also not be allowed an input credit for it. So if you can satisfy the minor test no FBT, no input credit and no tax deduction. If you do not satisfy the minor test FBT is payable and both the FBT, Christmas Party are tax deductible and you will be entitled to an input credit for the expense.

Employee Questions

Using Your Car for Work
Question -
I am considering buying a car and know that the majority of its use will be for business purposes. The other use will be driving to and from my workpace. How much of the car can I claim on my personal tax? I am also considering branding the car with the company logos as well.

Answer -
Branding won't help, you need to keep a log book. Have a look at our Claiming a Motor Vehicle booklet under Free Publications for details on how to keep the log book and what trips are claimable.