Property Investor Tips

How options can help minimise tax

Posted on Wednesday, May 06 2009 at 11:57 AM

Options, which provide the right to buy or sell a property at an agreed price, are one of the more useful devices that investors can use to manage their tax liabilities to achieve the best outcome from property transactions, according to BDO Kendalls partner Eddie Chung.

Chung says options are particularly useful when an investor wants to agree on the terms of a property transaction but hold off on settlement for a long period of time.

He explains: "Under the capital gains tax (CGT) provisions, a contract that gives rise to an obligation to buy and sell a property will normally trigger a CGT event, requiring the tax to be paid."

"This may be less than ideal, especially in situations where there is a substantial gap between the contract and settlement dates. In more extreme circumstances, the vendor may even find themselves having to find the cash to pay tax before receiving any of the settlement proceeds."

"This is where an option is invaluable. Under the law, if a vendor enters into an option to sell a property, no tax will generally be crystallised at that point, provided the option is exercised at a later date."

"To protect the interests of both the vendor and purchaser, a 'put and call option' may be used. The purchaser may exercise such an option by calling upon the vendor to sell the property, or the vendor may exercise the option by compelling the purchaser to buy the property under the terms of the option."

"When the option is exercised, the vendor will enter into a contract to sell the property, which may then trigger a CGT event. If the option was originally granted by the vendor for consideration, the amount paid for the option will be added to the cost base of the property for the purchaser and capital proceeds for the vendor."

"On the other hand, if the option is not renewed, extended, or exercised before it expires, the taxing point will be reverted to when the option was originally granted."

"This means the vendor will need to pay tax on any amount paid by the purchaser for the granting of the option, which could be nominal or for material value, depending on the commercial imperative behind the transaction."

"The tax rules applicable to options may come in handy in certain circumstances. Consider the scenario where a vendor agrees to sell a property to a purchaser for $500,000, and the latter does not have all the funds to settle. For example, they may have immediate funds of $100,000, but the remaining $400,000 may only be available in 12 months' time."

"To ensure the vendor does not trigger a CGT event and therefore an immediate tax liability, an option may be granted to the purchaser for $100,000. In 12 months' time, the option may then be exercised and the sale settled when the $400,000 becomes available."

"For the vendor, their CGT event for the sale of the property happened when the option was exercised, rather than when the option was entered into. The capital proceeds for the purpose of working out their CGT liability will be $100,000 (received upon the granting of the option) plus $400,000 (settlement monies), for a total of $500,000. For the purchaser, the cost base of the property will also be $500,000."

"As illustrated, an option may be used to manage the timing of when a CGT event happens to a property sale, which may be very useful in a variety of scenarios."

"However, depending on the jurisdiction, the granting of an option over land may be subject to stamp duty. Accordingly, a cost benefit analysis should be undertaken to ensure that the tax savings outweigh the costs in using an option."

"To that end, a good tax accountant should be able to suggest when it is appropriate to use an option to achieve the best result for their clients."

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