Understanding how profits will be treated for tax purposes is important before renovations start.
The hot property market has meant substantial increases in property prices, which has created a wave of new renovation projects; be it a home-owner renovating their residence prior to selling to increase its value; or individual’s ‘flipping’ properties (as seen from the countless shows on television) where a home in need of a little TLC is purchased under market value, renovated and sold.
Making a profit on these projects is great for everyone involved, but how does this affect your tax each year? Well, the Australian Taxation Office (ATO) has three broad classifications which will mean any profit made on the sale of renovated properties will be treated differently for tax purposes. We will explore these in detail below.
Personal Property Investor
Where the initial intention of owning the property was not to make a profit, any net gain or loss from the sale after renovation is treated as a capital gain or capital loss. Examples of this can be purchasing your main residence; or an investment property with the intention to rent it and make a long-term gain.
The advantages for a personal property investor are the access to Capital Gains Tax (CGT) concessions that may apply on capital gains made from the sale (such as the main residence exemption and the CGT discount); and you are not required to register for Goods and Services Tax (GST).
The disadvantage is if a capital loss is made, this can only be offset against current year capital gains. It cannot reduce other income in the current year, which means it will be carried forward to offset future capital gains.
Profit-making Activity of Property Renovations
If the purpose of purchasing the property is ‘flipping’ it to make a profit, any net gain (or loss) from the sale is added (or deducted) to your other income, which means it is not considered a capital gain or loss. You are also entitled to a apply for an Australian Business Number (ABN).
Advantages of this is if a net loss is made from the sale, this can reduce other income in the current year; and you may qualify for trade discounts through certain suppliers by providing your ABN.
However, disadvantages are the CGT concessions will not apply on any profits made on the sale; and you may be required to register for GST if the renovations on the property are substantial (this is determined on a case-by-case basis).
Business of Renovating Properties
This is can be compared to the profit-making activity of property renovations mentioned above, with the addition of other factors for it to be considered a business of renovating properties; the main one being repetition and regularity of the activity.
By conducting a business, the purchased properties are also considered as trading stock. As such, any expenses incurred for unsold properties at the end of a financial year are classified under closing stock on hand, and cannot be offset against other income until those properties are sold.
There is also the option of using alternative business structures rather than trading as a sole trader, which can help for tax planning purposes such as:
- Company: which has a fixed tax rate of 27.50% for businesses turning over below $25 million and the option of paying profits via a dividend;
- Trust: profits can be distributed to beneficiaries specified in the yearly resolution in accordance with the trust deed (losses are carried forward to future income years); and
- Partnership and Joint Venture: profits or losses are distributed to partners in the business
Now that you have a basic understanding of these three classifications, be sure to know which one you fall under and how it will affect your tax this year. If you would like more information or would like to discuss your particular circumstances, please contact you William Buck advisor.