# Capital gains tax question

#### Quasar217

I'm thinking of selling my first IP because it's increased in value enormously and the rental return is absolutely rubbish at the moment.

Just looking at capital gains tax, and it seems a bit complex. I originally bought the flat to live in in 1998, lived there for 5 years, bought a house with my wife in 2001, but rented it out for 2 years before moving in in 2003. We have since sold that house and upgraded, claiming PPOR exemption for that place last year when we sold it and bought a new one.

If I were to sell the IP, how would I calculate the CGT I'd need to pay? I estimate the value has increased by about 250% since I bought it, but can't see much further growth for quite a while as rents haven't kept pace with prices in the area. Is there anyway to minimise the CGT or is it too late now (it's a one bedroom flat, so moving in there for a family with 2 kids isn't really an option!).

#### Rixter

If I were to sell the IP, how would I calculate the CGT I'd need to pay? I estimate the value has increased by about 250% since I bought it, but can't see much further growth for quite a while as rents haven't kept pace with prices in the area. Is there anyway to minimise the CGT or is it too late now (it's a one bedroom flat, so moving in there for a family with 2 kids isn't really an option!).

My understanding is the CGT calculation will be worked out on what ever the property's value was when it became an IP and whatever it sells for now.

Because it has been a IP for greater than 12 months you will be entitled to 50% discount on the profit.

That discounted profit figure then gets included with your other taxable income for the same financial year you sell the IP in.

For example if the CG profit from when it became an IP to when you sell is \$200k and you have owned it greater than 12 months, and your other taxable income for that year was \$75k then - \$200k x 50% = \$100k (putting aside any deprec adjustments etc) + \$75k = \$175k taxable income.

So you will then pay tax on \$175k for that year.

Like I said, that is only my understanding as my investment philosophy is to never ever sell so I cant comment based on my own personal selling experience. I strongly suggest you run your situation past your own personal tax adviser to clarify your exact position.

I hope this helps.

One last query on your comments tho, how does the rent not keeping pace with recent CG effect your projected future CG predictions if you were to hold onto the property

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#### Terryw

I would think you can claim it as your main residence until 2003 and it would be CGT exempt during this period. So you will need to determine the value at this time and the CGT will be:
sale price - value 2003 less costs + depreciation added back = CG

This is then x50% and added to your income.

#### Quasar217

So you will then pay tax on \$175k for that year.

Like I said, that is only my understanding as my investment philosophy is to never ever sell so I cant comment based on my own personal selling experience. I strongly suggest you run your situation past your own personal tax adviser to clarify your exact position.

I hope this helps.

One last query on your comments tho, how does the rent not keeping pace with recent CG effect your projected future CG predictions if you were to hold onto the property

It's always been my own philosophy to never sell, too, but it's hard to reconcile the fact that I'm now getting about a 1% return after expenses on the current value of this place. I could sell up and net about \$250K after paying off the small loan still on it, and put that in the bank at 6% or so.

I don't think there will be much more capital growth in general in Melbourne, and this place in particular, because rent return is so low now. It can't keep diverging forever, and \$300K for a one bedroom flat is a ridiculous price.

However I have to weigh up the major CGT impact of selling as well, and it may well work out that I'm better just accepting the lower return for a while. It's not actually costing me money, it's just when you look at it in terms of opportunity cost it's not good. It's a flat so I can't do much to add value to it now.

#### Rixter

It's always been my own philosophy to never sell, too, but it's hard to reconcile the fact that I'm now getting about a 1% return after expenses on the current value of this place. I could sell up and net about \$250K after paying off the small loan still on it, and put that in the bank at 6% or so.

I think you're looking at it from the wrong perspective..You say you've had it since 1998, only have a small debt against it now, and its not costing you any money then why are you calculating 1% yield on current approx values? Current value is not what it cost you is it? I think you are losing sight of the forest by the imaginary trees.

IMHO what I would be doing is leveraging against it into further investments thereby inceasing your asset base and exposure to further growth.

The unit is not going to get any cheaper.

#### Intellikev

A simple way to answer this question:

Purchased in 1998 for: \$120,000
Costs Associated with Purchase \$ 10,000

Lived in for 5 years to 2003. Value at that time \$200,000

Value now \$300,000
Costs to sell (Approx.) \$ 10,000

CGT is Sale Price less Adjusted Cost Base x 50%

\$300,000
- \$220,000
= \$80,000

Net CGT \$80,000 x 50% = \$40,000

The \$40,000 is then added to your assessable income and taxed at your marginal tax rate.

Be careful as the CGT comes into effect on the day you sign the contract for sale not when the sale is effected.

As a separate matter if you had sold the property before 6 years had elapsed you may have been able to avoid any CGT.

Have a chat with your accountant.

Hope this clarifies things.

#### Quasar217

I think you're looking at it from the wrong perspective.. Why are you calculating yield on current approx values? Current value is not what it cost you is it?

You say you've had it since 1998 and only have a small debt against it now.

What you should be doing is leveraging against it into further investments thereby inceasing your asset base and exposure to further growth.

That's quite true - if you calculate it on what I originally paid for it, net yield is around 8% - quite good but everyone says you have to consider opportunity cost, and it is supposedly worth nearly \$300K but certainly not making my day-to-day life easier.

I did borrow against it and bought two more IPs over the last 4 years, which have had modest, though not spectacular growth. They have far better rental yields though and both have LVRs around the 70% mark now and pay for themselves (though may slip negative again with rising interest rates).

I'm not going to buy any more in the current overpriced market, which I expect to fall a little or stagnate for some time with rising rates. So I'm concentrating on paying down the existing loans. Eventually they all have to be paid off - the tenants cover the interest but I'm putting as much of my own money into paying off the capital as possible - in an offset account initially so it's still there in case of emergencies.

We've never been comfortable with the more aggressive investment strategies - PPOR is fully paid off but we've always quarantined it from investment borrowings and never used it as security, to keep it safe if anything went wrong. And now we're on a single income with two kids we don't want to be getting into any more debt.

#### Quasar217

A simple way to answer this question:

Purchased in 1998 for: \$120,000
Costs Associated with Purchase \$ 10,000

Lived in for 5 years to 2003. Value at that time \$200,000

Value now \$300,000
Costs to sell (Approx.) \$ 10,000

CGT is Sale Price less Adjusted Cost Base x 50%

\$300,000
- \$220,000
= \$80,000

Net CGT \$80,000 x 50% = \$40,000

The \$40,000 is then added to your assessable income and taxed at your marginal tax rate.

Be careful as the CGT comes into effect on the day you sign the contract for sale not when the sale is effected.

As a separate matter if you had sold the property before 6 years had elapsed you may have been able to avoid any CGT.

Have a chat with your accountant.

Hope this clarifies things.

How would I work out what the value was in 2003? Do I need to use an average for properties of that type in the area?

#### Rixter

That's quite true - if you calculate it on what I originally paid for it, net yield is around 8% - quite good but everyone says you have to consider opportunity cost, and it is supposedly worth nearly \$300K but certainly not making my day-to-day life easier.

Can you explain to me what opportunity cost actually is? I would have thought having a property putting money into your pocket from a cash flow perspective and grown in value by 250k would be classed an advantage to making life easier.

#### jaycee

Can you explain to me what opportunity cost actually is?

Have you not heard the term opportunity cost before ?

Somersofters have used it in this forum enough times for me to have noticed it.

what are you trying to actually say ?

#### Rixter

Have you not heard the term opportunity cost before ?

Somersofters have used it in this forum enough times for me to have noticed it.

what are you trying to actually say ?

I know what it is to me but I dont know what it is to quasar. Im trying to get quasar to explain his/her perspective of lost opportunity cost and how he/she derives it from his/her situation.

In other words, how is having a property that puts money into your pocket and has grown in value by 250k be looked upon as lost opportunity and not make life easier.

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#### Quasar217

I know what it is to me but I dont know what it is to quasar. Im trying to get quasar to explain his/her perspective of lost opportunity cost and how he/she derives it from his/her situation.

In other words, how is having a property that puts money into your pocket and has grown in value by 250k be looked upon as lost opportunity and not make life easier.

It's done really well and I'm quite happy with the growth, but the rent is quite low, and there are high costs (body corporate, and water rates and usage as the flat is not individually metered). So I'm just thinking how that money could be better placed than tied up in something with such a low return. There are plenty of discussions on this forum and others about just that issue. It is positive cashflow, but only by a couple of thousand a year, which isn't much considering the equity that's now tied up in it.

#### Terryw

I agree that you should look at the return based on current value and look at selling if you can get better returns elsewhere - this is the opportunity cost of not acting.

So I would suggest you look at what you will receive after all costs from the sale and see if investing this money elsewhere will be making a better return. Though this can be hard to judge as if you sell prices of property may rise and the new investment may not perform as expected.

#### Quasar217

So I would suggest you look at what you will receive after all costs from the sale and see if investing this money elsewhere will be making a better return. Though this can be hard to judge as if you sell prices of property may rise and the new investment may not perform as expected.

Well I've done the sums and I don't think it would be worth it as it looks like I'll be up for around \$40,000 CGT and my wife would lose family tax benefits for the year as well. So it looks like I'll be hanging on to it for a while. That CGT sure is a killer.

Thanks everyone for your help.

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#### Rixter

Well I've done the sums and I don't think it would be worth it as it looks like I'll be up for around \$40,000 CGT and my wife would lose family tax benefits for the year as well. So it looks like I'll be hanging on to it for a while. That CGT sure is a killer.

Just redraw the equity out to use as you want income tax free - financially you will be miles ahead. No CGT, No Selling costs, and No Loss of future income source by selling on capital growth to who ever buys it.

#### willair

Just redraw the equity out to use as you want income tax free - financially you will be miles ahead. No CGT, No Selling costs, and No Loss of future income by selling on capital growth to who ever buys it.
When you say Tax free ,can you explain how this works or the way you use the system..willair..
'

#### Rixter

When you say Tax free ,can you explain how this works or the way you use the system..willair..
'

You set up a loan (LOC and/or loan with offset savings account attached etc) secured against the property. You then draw down on this loan when ever you want ie weekly, fortnightly, monthly etc.

For example if you have a property valued at \$800k with an existing loan of \$400k the banks will allow you to draw out up to 80% of the value providing you have structured yourself correctly to meet the lender's serviceability criteria.

So \$800k x 80% = \$640k - \$400k = \$240k available equity for redraw. If you redraw say \$2k per week you use \$104k of that \$240k with \$136k still available.

Because you are drawing out equity via a loan it does not trigger any income tax ruling by the ATO. What would you have to earn gross to net \$104k in the hand if you had to get up out of bed each morning to go out and earn it?

Use in conjunction with a LOE investment strategy as per my chosen CGA Property Investment Strategy.

I hope this helps.

#### Terryw

Rick - good in theory, but banks are very reluctant to give people access to equity these days. Max cash out is around \$10k. Most banks will only lender more if you are buying shares or property etc and then they want to control the disbursement of the money.

#### Rixter

Rick - good in theory, but banks are very reluctant to give people access to equity these days. Max cash out is around \$10k. Most banks will only lender more if you are buying shares or property etc and then they want to control the disbursement of the money.

Terry, like I said - subjecting to lending criteria. Just like any form of lending one needs to have already structures themselves to meet the criteria otherwise they will encounter issues. Its not a problem unless ones put themselves in a position for it to be or become one.

Hope this helps.

#### Terryw

Yes there are ways around it, but these days it is generally just not possible to just get a LOC and live on borrowed money. its not that simple anymore.

One way around it is to buy shares and then immediately sell, pay down the loan and then you will have the funds available.

Another may be to borrow to buy higher yielding shares and to live on the dividends or use Keithj's strategy and margin the shares and buy twice as many and to capitalise the interest while living on dividends etc.

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