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Building or renovating for profit
A continuation of Julia Hartman's tax article in November’s edition of API magazine...
What sort of structure to use?
If you give up your day job and embark on renovations or work in an industry related to renovating houses, you’re going to have a lot of difficulty arguing the project is anything less than a business.
Having accepted your fate as being liable for GST if the property is substantially renovated and not qualifying for any CGT concession because you purchased with the intention of resale, let’s have a look at what name you should hold the property in.
Once you have given up hope of qualifying for the main residence exemption you have no real incentive to hold the property in your own name.
If you’re concerned about your other assets being exposed to legal action in relation to the renovation or your personal situation (i.e. occupation) you may want to hold the property in something other than your own name. Further, once you concede you’re in business you may as well take advantage of the Fringe Benefits Tax concessions which can only be provided to employees. If the property is in your own name you can’t be an employee of yourself.
Conceding that you can’t qualify for the 50 per cent CGT discount also eliminates the barrier to utilising a company. Companies don’t qualify for the 50 per cent CGT discount so are generally not suitable for holding investment properties.
The attraction of companies is that they’re only taxed at 30 per cent, though if you want to take the money out of the company for your own use then you’ll have to top up that 30 per cent to whatever your personal tax rate is.
If you’re looking to retain the profits of your renovations to finance future renovations then a company is a very effective way to do this at the 30 per cent tax rate, but don’t just accept this as the way to go.
Individuals are only taxed at more than 31.5 per cent when their income exceeds $80,000, so if you’re a couple and only expecting to make a profit of $160,000 per year you can retain profits in your own name for virtually the same tax rate.
A discretionary trust with a corporate trustee will give you the same asset protection but profit distributions won’t be limited to shareholders. Even your unborn children can be provided for, though of course they can’t receive any profits until they’re born.
With the future increases in the low income tax offset, distributing profit to your children is becoming more attractive.
Trusts are taxed at the maximum tax rate on any profits that aren’t distributed to other entities, though you can make a company a beneficiary of a trust and park the profits there at the 30 per cent tax rate if your family’s personal tax rates exceed that.
If you’re considering using a hybrid trust I’d encourage you to first read the June edition of API and the second (online) part of that article posted here.
Finance
My finance broker informs me that whether you operate as a trust, company or sole trader it will make no difference to the bank.
If you have given up your day job you’re going to need some money to live off.
If you have to borrow this make sure the loan is separate from the one for the property, as the interest on your borrowings to live off won’t be tax deductible unless you operate as a company or trust which borrows the money to pay you wages on which you’ll have to pay tax.
If you have some ready cash try to keep this for living expenses rather than increasing your deposit, if possible.
The cash can be put into an offset account reducing the interest on the loan the same as it would have if you had used it as a deposit, but won’t be creating borrowings for private purposes as you draw out of the offset account for living expenses. This means the increased interest as a result is fully deductible.
Julia Hartman is a CPA, registered tax agent and founder of BAN TACS Accountants Pty Ltd. She’s also co-author of Saving Tax on Your Investment Property, available from Business Mall.
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.
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