Recently we kicked off a series of discussions designed to help inform our readers regarding the tax treatment of property investing in 2021.
We are breaking it down into three stages being –
- Tax Implications of Investment Property Acquisition
- Tax Implications of Investment Property Ownership, and
- Tax Implications of Investment Property Disposal.
In our first post we started with the Tax Implications of Investment Property Acquisition looking at –
- Transfer Duty (previously known as Stamp Duty)
- Goods & Services Tax (“GST”)
- Foreign Residents Withholding Tax
Then we moved onto the Tax Implications of Investment Property Ownership starting with –
- Goods & Services Tax (“GST”),
- Land Tax.
Then we turned to –
- Income Tax (in Demystifying the Tax Implications of Property Investment in 2021 (Continued – Part 2)), and
- Negative Gearing (in Demystifying the Tax Implications of Property Investment in 2021 (Continued – Part 3)).
So now lets consider the…
Tax Implications of Investment Property Disposal
The good news is there are only two taxes that generally need to be considered on disposal of an investment property. They are –
- Goods & Services Tax (“GST”), and
- Income Tax
But things get more complex from there very quickly.
Goods & Services Tax (“GST”)
Once again we must break the discussion down into Residential and Non-Residential property.
As discussed in previous posts on the topic of the tax implications of property investment, in the majority of property transactions neither the purchaser nor the seller need to worry about GST.
That is because GST does not apply to residential property transactions. With one exception…
GST does apply if you are selling ‘new’ residential property. For example where you are selling a newly built home or apartment.
Traditionally, in the majority of these cases it was the seller that needed to worry about the GST and how to deal with it.
And for the most part purchasers still don’t need to worry about GST in terms of it being an additional cost.
However, under recently introduced rules, the purchaser now needs to pay the GST component of their new residential property purchase price to the ATO, instead of paying it to the seller.
So if you are disposing of new residential property, you need to understand that at settlement, you will not receive the GST component of the sale price, it will be paid directly to the ATO by the buyer.
So, how much GST will you lose?
Worst case scenario, 1/11th of the sale price will be GST that will go to the ATO. So if you sell your newly built investment home for $500,000, $45,454.55 will be paid (or payable if for some reason the buyer doesn’t withhold the amount) to the ATO.
The Margin Scheme
There is however a component of the GST legislation known as the ‘margin scheme”. And it is designed to take into account the the fact that the seller of new residential property may not have received full GST credits on all of their costs of purchase and therefore they shouldn’t have to pay full GST on the sale price.
If you acquire an existing residential property there will be no GST in the purchase price. So you can’t claim back any GST from the ATO on the transaction.
Then if you clear the block and build a new house, when you come to sell it, it will now qualify as new residential property and therefore now be subject to GST. However, to impose GST on the entire sale price would be unfair.
So this is where the margin scheme comes into play.
Illustrative Example 4
Jane purchases an existing residential property (with a house on it) for $350,000. There is no GST in the purchase price, so she can not claim back any of the price paid from the ATO.
She clears the block and builds a new house for $330,000. Now the costs of development will include GST and she will get to claim that back from the ATO over the course of the development (a topic for another time). To keep things simple we will assume all costs include the full amount of GST. So 1/11th of $330,000 is $30,000, and therefore after the refund her net cost of development is only $300,000.
Therefore her total cost of her investment, after GST credits, is $650,000 ($350,000 plus $300,000).
Jane then sells the new residential property for $880.000.
If the margin scheme did not apply, she would have to pay 1/11th of the $880,000 to the ATO. That is $80,000, leaving her with $800,000. In that case her profit is $150,000 ($800,000 – $650,000).
But if the margin scheme does apply, she only has to pay GST on the ‘margin’ between the original property purchase price of $350,000 and the sale price of $880,000. That margin is $530,000 ($880,000 – $350,000).
1/11th of $530,000 is only $48,181.82.
The result is her profit is now $181,818.18 (($880,000 – 48,181.82) – $650,000).
There are very specific requirements around gaining access to the margin scheme, including both the seller and the buyer agreeing in writing that it is applicable to the transaction. If you don’t get it right at the time of signing the sale contract, the opportunity will be lost. So get advice BEFORE proceeding with the sale of any property that could potentially be considered ‘new residential property’.
Non-Residential Property (including Vacant land)
Once again as discussed in previous posts on the topic of the tax implications of property investment, GST generally always applies to non-residential property. There can be some exceptions, and as discussed below exemptions, but the safe bet in the first instance is to assume a sale of non-residential property will have GST implications.
There is generally no equivalent of the margin scheme in relation to non-residential property.
Therefore, 1/11th of the sale price of any non-residential property, will be payable to the ATO unless an exemption applies.
The Margin Scheme and Vacant Land
Having said that, throughout our series of posts we have generally lumped vacant land in with non-residential property. However, when it comes to the margin scheme there is an exception to the rule. The margin scheme can apply to the sale of vacant land in certain circumstances including where you are undertaking a business (more technically correctly referred to as an ‘enterprise’) of property development.
GST Exemption Where the Sale is of a Going Concern
The concept of ‘going concern’ is usually applied in relation to businesses. However, for the purpose of GST, it is also applicable to non-residential property that is leased to a commercial tenant.
So, if a non-residential property has an existing tenant, and the tenant will continue to occupy the building after the sale, then the seller and buyer can agree to apply the ‘going concern GST exemption’.
This means the sale price will no longer include any GST. And therefore the seller does not need to pay any GST to the ATO.
Generally, where the exemption can apply, both the buyer and the seller will want to apply it. It just makes everything easier, in particular it makes managing cash flow much easier for the buyer (therefore possibly resulting in them agreeing to pay a slightly higher price, or at least making it easier for them to secure finance and make the contract unconditional).
But as always, in order for the exemption to apply very specific requirements must be met, therefore advice is always recommended, especially for the seller as indicated below…
When it comes to the going concern GST exemption the primary risk lies with the seller. Sure the buyer should make sure it is being applied correctly, as it could have implications for them, but it is the seller who is most at risk of being out of pocket if they get it wrong.
If you get it wrong, and it is later determined the going concern GST exemption did not actually apply, the seller will owe 1/11th of the sale price to the ATO, and that is regardless of whether the buyer pays the extra amount to them or not.
So it is absolutely vital for both parties, but in particular the seller, to seek advice and ensure they get the use of the going concern GST exemption right.
We will discuss the income tax implications of selling an investment property in a future article.