April 2007

CGT exemption, rent existing home, decision time, best use of inheritance, and where to invest.

Our panel of experts answers property investment questions from API readers. For more Q&As, see this month’s API magazine.

CGT exemption

Q: If I buy a block of land, build a house on it, and sell it after it's completed, will I qualify for the 50 per cent discount on CGT if the time between the purchase of the land and the sale of the completed house is more than 12 months? Or do I need to hold the completed house for 12 months to qualify for the 50 per cent discount? If I subdivide the land and build two houses on it, will the calculation of CGT be the same?

A: This is a potential trap for you. If your intention was to undertake a profit making activity of buying, building and selling the property then the Tax Office may treat this activity as a business and accordingly no CGT issues will apply. This would particularly be the case if you claimed back the GST incurred in the development in your BAS or you did this development more than once. However, assuming this is a one-off transaction where your intentions changed, then the CGT discount dates will be from the date of the purchase of the land and not from the date of the building construction.

Yes, at face value the same CGT issues apply (subject to the Tax Office not thinking of you in the business of developing and therefore treating you as taxed on the profit and not on the capital gain) to a subdivision where two units are built, not one. You would be wise to speak to your accountant about these issues in more detail. Dale Gatherum-Goss

Editor’s note: see story on page 68 of the April 2007 API for more information about the ATO and how it views property developments.

Is there a solution?

Q: I have a friend whose house is fully paid off and he plans to buy a nicer house to move into and rent out the existing home. A tax agent friend mentioned that it may not be possible to refinance and negative gear the existing home. A tax answer in the January issue of your magazine suggests this may be true. My question is, what is the intelligent investor’s solution to this problem? It certainly doesn’t make sense to sell the home and buy another to rent as you bleed money in fees, nor is it sensible to rent out a fully paid home and carry a mortgage on the home you live in. Surely there’s a basic solution. Help!  

A: I’m afraid there’s no easy answer to your question. Everyone’s circumstances are different and although there are options (such as selling the home to a trust or to a spouse) each of those options has problems and issues involved which are beyond the scope of a Q&A format. Otherwise, this is indeed a typical problem with no easy solution. Sorry. Dale Gatherum-Goss

Decision time

Q: My mother is 69 and is retired and on the pension. She lives in Queensland, about 15 minutes from Toowoomba. I live in Sydney and mum and I have discussed her making the move down south as my father passed away two years ago and I would feel more at ease if she was a lot closer. I’m going to advise her to reside on the Central Coast, away from the hustle and bustle. Mum owns the house she lives in which is roughly worth about $300,000, however recently she went guarantor on a home loan for me and used $38,000 from her property value (I needed this amount to make the 20 per cent deposit). If mum made the move what would be the best thing to do?

1. Sell her house and buy down here? If so, what’s the property market like up there at the moment?
2. Keep the house and rent it out?
3. How does that $38,000 affect the sale of her house? What options have we got around this? 

A: The key here is to look at how the property market in Toowoomba compares with the property market on the NSW Central Coast. Generally speaking, the Central Coast market experiences more demand than the Toowoomba market, so prices are likely to be higher, and property values will increase more quickly.

Your mother needs to work out what it will cost her to get into the Central Coast market, compared with what her current home is worth. If she’s looking for a home of a comparable size and degree of renovation, the sale proceeds from her Toowoomba home may not be enough to get her into the new market. In this case, she may have to modify her expectations and look at smaller properties, or properties set a fair distance back from the beach, which are generally less expensive.

At age 69, your mother’s future lifestyle needs also come into play. For example, she may want a high-set house now, but will she be so keen in the years to come if climbing stairs becomes a problem? If she can’t buy the kind of house that will suit her current and future lifestyle needs, she may consider keeping the Toowoomba home and renting it out. However, the rent from that property may not be enough to cancel out the rent she’ll pay on a Central Coast property – leaving her with a shortfall. Unless your mother has another source of income to fund the shortfall, she may not be prepared to take this risk.

Regarding the $38,000 from your mother’s home that funded your deposit, there is a preferred option, and two fallbacks.

The first option is to try and get your property loan refinanced. If the property has grown sufficiently in value since you bought it, you may no longer need your mother as guarantor and her home won’t be required as security. This is the lowest risk and most preferable option.

If this isn’t viable, your mother has two other options, although both assume that she sells in Toowoomba and buys on the Central Coast. She could give you $38,000 from the sale proceeds, but this will reduce her available funds and may make it harder to get into the new market. Alternatively, she can try to coordinate the settlement of both properties. If she can buy and sell on the same day, she may be able to transfer the $38,000 and secure it against the Central Coast property. David Johnston

Best use of inheritance

Q: I have a mortgage, credit card debt and personal loans and have just received an inheritance of $25,000. Based on the above, is it possible for me to purchase an investment property, not having any savings and having debt? I have a very average income. Or am I better to use this money to pay off the debts?

A: You need to take a holistic approach to your situation. This should involve doing your homework in regard to the best tried and true formulas for successful property investing. Seek out an independent property advisory company and find out firsthand what’s involved rather than just going into the market “cold” and assuming all property must be good property. Depending on where you live, there are some very good property investment forums that you can attend for little cost. At the same time, you need to access some independent financial advice. Your options will depend on how much debt you have and how capable you are of servicing that debt. Factors such as the level of equity you have in your current property also need to be taken into account. Once you have a clear picture of your financial situation, your ability to handle the costs of an investment property, including stamp duty and other entry costs and then taking into account rental income and negative gearing tax provisions, should give you a clear picture of what you can achieve. Don’t be daunted by having an average income. Many successful property investors have started from a modest income base, but armed with the right independent investment property and financial information have successfully built portfolios that show strong capital gain and an increase in equity. Monique Wakelin

Where to invest

Q: My husband and I currently have a home and one investment property and I want to start a property portfolio with a long-term goal towards capital growth. We want to know if we should put all our eggs in one basket and buy a property in Shell Harbour or should we start by purchasing two to three homes in regional areas where the rent will cover the loan?

A: If capital growth is your goal then stick to prime inner urban areas – 2 to 10 km from major CBDs. Properly selected inner urban property will not only deliver that capital growth, but will provide consistent rental income off the back of high and continuing demand. How you deploy your funds into the market depends on the amount you have to invest. For instance, up to $300,000 will buy a top-notch apartment in the Melbourne market. If you’re looking at around $500,000, then this will be a properly selected apartment in the right location and with scarcity value on the Sydney market or a top performing smaller inner urban house in Melbourne. This amount may also buy either one good house or two apartments in the smaller capitals such as Hobart or Adelaide. Between about $650,000 and $1 million will buy both a house and apartment. The greater the amount of capital you have, the more diversity you should aim for in a portfolio. If your current investment property is a house, then look at purchasing an apartment or a different style of house in a different inner urban location. In other words, don’t just stick to all Edwardian properties or all art deco. Not all property moves in a uniform way in any cycle and having this diverse mix evens out any cyclical ups and downs over the longer term. Steer clear of regional areas. One prime inner urban property will outperform two or three in most regional areas. Monique Wakelin

Have a question? If you have a question you’d like to ask our panel of experts, please send it to: editor@apimagazine.com.au Please keep questions to 150 words or less.

This information is of a general nature only and does not constitute professional advice. Readers should not act on the basis of any matter on this website without taking professional advice with due regard to their own particular circumstances. The authors and publishers expressly disclaim all and any liability to any person, in respect of anything and of the consequences of anything done or omitted to be done by any such person in reliance, whether in whole or in part, upon the whole or any part of the contents of this website.