Offsetting Capital Gains by selling shares at a loss

[Lacasa]

Hi all, as maths is not my strongest subject, I would appreciate any savvy forumites helping me out with this two part question on Capital Gains and selling shares at a loss to offset Capital Gains.

Here is the data:
Bought an old house for 213 000, demolished the property and built 2 houses on the block at a cost of 128 000 per house. Have held the properties for 5 years and recently sold one of the houses for $512 000. After all the selling fees and paying the outstanding mortgage of $196 000 on the one property, I was left with $300 000 “profit,” minus whatever my capital gains tax is going to be this year? Currently working part time and expect a total income for the year to be approximately $60 000. Can anyone calculate approximately what I will owe the taxman??

Second part of the question: I have some shares that have done badly over the last 12 months. Original value $100 000 now down to $20 000, and don’t expect these to rise to the levels they were for a long time, if ever! So is it worth taking a capital loss on the shares to reduce the capital gain on the property I sold??? Can anyone calculate what I would be looking at paying the taxman if I did this??

Cheers
Lacasa

 

[JoyBoy]

I'll give it a crack...
When you demolished the house, the actual house itself (separate from the land) is considered a CGT asset. A CGT event occurs when you destroy the house and you make a CGT loss on the destruction of the house. To simplify matters, lets not take this into account for the time being.

When you split the land into two, you will need to divide the cost base ($213,000) into two so that the new cost base of each property is (213,000/2) + 128,000 = $234,000. Since you sold the property for $512,000 your capital gain is $512,000-$234,000 = $278,000. This amount is reduced by 50% due to the CGT discount for assets held for longer than 12 months so the amount you need to include in your assessable income is $139,000.

Taking into account the marginal tax scales, the first $20,000 will be taxed at 30%. The next $100,000 is taxed at 40% and the remaining $19,000 will be taxed at 45%. So you'll be paying $54,550 in tax.

You'll also need to pay medicare levy of 1% and medicare levy surcharge of 1.5% if you don't have private health cover.

I think that's correct.

 

[TheDoctor]

To calculate the capital gains tax correctly slightly more information is needed.

1. Generally speaking, your "profit" (being how much cash you receive in the end) is irrelevant for CGT. What is important is the selling price.

2. Your capital gain is calculated by your sale proceeds less your 'cost base' which is made up of any incidental selling/purchasing costs, the cost of the land and the cost of building. As you bought one block and then subdivided into two you would have to split your land cost between the two buildings (assuming for this a 50/50 split).

3. As you have held the properties for over 12 months you're allowed a 50% reduction on this capital gains figure. The end figure is then added to your total taxable income for the year.

At a quick glance your taxable income will be as following:

Capital Gain = (496,000(*) - 106,500 - 128,000) / 2 = $130,750
Salary = $60,000

Total: $190,750

Approx. Tax on the above (2009 tax year) = 62,837

NB1: however that your employer probably has been taking out PAYG withholding from your salary which will reduce the actual amount YOU have to pay. You can see this amount on your payslips / PAYG Payment Summary (Group Certificate).

NB2: I made the proceeds amount $496,000 by adding your "profit" to the amount of your mortgage. This way it should take into account any selling fees you paid as well.

NB3: As JoyBoy said the demolishing of the orginal house would be a CGT event. This would work to your advantage though but I have disregarded it in the above scenario.

I would however recommend seeing an accountant.

I will answer the second part of the question once I get to work.

 

[TheDoctor]

Ok I'm at work. To answer your second question.

On those shares, it looks like you've made a $80,000 loss which can be used to offset the above capital gain. However, this loss must be applied BEFORE the 50% reduction. Therefore, using the above figures, your tax liability would be:

Capital Gain: (496,000 - 106,500 - 128,000 - 80,000) / 2 = $90,750
Salary: $60,000

Taxable Income: $150,750

Approx. Tax on Above: $46,300

Difference in tax between the two scenarios: $16,537.

NB1: As said in my above post, your PAYG Withholding will offset some of the above tax.

I would strongly recommend seeing an accountant to prepare your tax return for this. It is well worth the cost to achieve the best result and any errors.

If you have any further questions just ask away

 

[Rob G.]

Have held the properties for 5 years and recently sold one of the houses for $512 000.

Have you rented it out (or had it available or used for income) & could claim building allowances ?


So is it worth taking a capital loss on the shares to reduce the capital gain on the property I sold???

Is this a Part IVA avoidance issue, or were you intending to sell the shares regardless?

Cheers,

Rob

 

[Lacasa]

Thanks JoyBoy and TheDoctor that has clarified a lot for me. Will definitely be speaking with my accountant on the subject, but now I have a good idea of what I'm speaking about and more or less what to expect.

Rob G.
The property was an IP and rented out for the 5 years. I did not do a depreciation schedule on the property - is that what you mean by building allowance?

The shares I still have, I just thought since three factors had come together this year (selling an IP, having a part-time job so less income for the year, and having a share portfolio that took a dive) it was an opportune time offset the loss with the shares free up some extra cash.

Looking at the figures provided by TheDoctor I will probably hold on to the shares anyhow, as they could recover to more that the 16 537k difference it would make to my Capital Gains tax payment over the next couple of years.

Regards
Lacasa

 

[TheDoctor]

The shares I still have, I just thought since three factors had come together this year (selling an IP, having a part-time job so less income for the year, and having a share portfolio that took a dive) it was an opportune time offset the loss with the shares free up some extra cash.

I'll explain what he meant by Part IVA (Rob, you can correct me if I miss out anything). Part IVA is an anti-avoidance provision in the tax act. It's purpose is to disallow any transactions which have no real commercial substance and are instead simply transacted for the sole purpose of reducing/avoiding tax. It raises a heap of issues and question. As it's perfectly legal to structure your affairs tax "effective", at what point does effective become avoidance?....

However, I would say you would have no issues whatsoever as long as:

a) You don't mention to the ATO "I sold the shares to reduce my capital gain"....but you can always say "I sold the shares cause I didn't think they would go up again anytime soon and my money could be better used elsewhere"

b) You don't buy back the shares on or around the same day. i.e. you now have a crystallised capital loss but you still hold the shares. So there has be no "economic change" in your holdings. This is called a 'wash sale' and is a big no-no.

Other than that, you should be good.

 

[TheDoctor]

The property was an IP and rented out for the 5 years. I did not do a depreciation schedule on the property - is that what you mean by building allowance?

During the time you rented out the property you would've been able to claim a building allowance deduction (also called capital works) at 2.5%p.a. of your building costs. The amount of your total claims needs to be taken off your cost base (increasing your capital gain). Essentially you have 'used' some of your cost base as a deduction.

Unfortunately, if you were able to claim the deduction and still have the ability to amend those prior year returns to include the deduction, the law takes the view that you have done so.

 

[Lacasa]

During the time you rented out the property you would've been able to claim a building allowance deduction (also called capital works) at 2.5%p.a. of your building costs. The amount of your total claims needs to be taken off your cost base (increasing your capital gain). Essentially you have 'used' some of your cost base as a deduction.

Unfortunately, if you were able to claim the deduction and still have the ability to amend those prior year returns to include the deduction, the law takes the view that you have done so.

But I did not make any claims in regards to building allowances, so why would that increase my capital gain. I am told that if I had done a depreciation schedule on the property that would affect my capital gain, but never heard of the capitol works issue?

Lacasa

 

[TheDoctor]

But I did not make any claims in regards to building allowances, so why would that increase my capital gain. I am told that if I had done a depreciation schedule on the property that would affect my capital gain, but never heard of the capitol works issue?

Lacasa

There are two different forms of allowances.
Capital allowances (or depreciation) is for plant & equipment (fridges, stoves, etc).
Capital works is a write off for the building costs of 2.5%p.a and reduced your cost base. (a good depreciation report usually includes this as well.)

The law takes the view that if you COULD have claimed the capital works deduction and still have the ability to amend those prior year returns to include it - then you have done so. So even though you haven't claimed a capital works deduction for the last five years, you are still able to amend those prior year returns. As such, the law deems that you have/will do this.

A link which may interest you is this page on the ATO website

You will probably note it says

However, if you omitted to claim capital works deductions because you did not have sufficient information to determine the amount and nature of the construction expenditure, there is no need to exclude the amount of such deductions from the cost base of the CGT asset.

but as you know how much it cost you to build the new building, I don't think you could make this argument.

 

[WillG]

It may work out to your advantage if you do claim depreciation for the past 5 years.

for example:

If depreciation is $28k for the past 5 years
(your depreciation may be more due to depreciation on floor and window coverings etc)

Capital Gain: (496,000 - 106,500 - 128,000 + 28,000 - 80,000) / 2 = $105,000
Salary: $60,000 - $28k = $32k

Taxable Income: $137,000 rather than $150,750

This means about $5500 less in tax

 

[TheDoctor]

It may work out to your advantage if you do claim depreciation for the past 5 years.

for example:

If depreciation is $28k for the past 5 years
(your depreciation may be more due to depreciation on floor and window coverings etc)

Capital Gain: (496,000 - 106,500 - 128,000 + 28,000 - 80,000) / 2 = $105,000
Salary: $60,000 - $28k = $32k

Taxable Income: $137,000 rather than $150,750

This means about $5500 less in tax

Which I feel would be less than it would cost to pay an accountant to amend the returns and to get some advice re your 2009 tax return.

Note though, if you are going to go to an accountant for advice (and not to just complete your return), do so BEFORE 30 June. I'm sorry if that sounds completely obvious but I (being an accountant) get so many people coming and asking for advice in July or August and by that stage it is usually too late.

 

[WillG]

Which I feel would be less than it would cost to pay an accountant to amend the returns and to get some advice re your 2009 tax return.

How much time is involved in amending a tax return? Is it something a savvy property investor could do in a couple of days?

Note: I haven't had to amend a tax tax return and are not across the complexities but if you have a depreciation report, is it as simple as recalculating the net rent and taxable income for each year?

Cheers

 

[TheDoctor]

How much time is involved in amending a tax return? Is it something a savvy property investor could do in a couple of days?

Note: I haven't had to amend a tax tax return and are not across the complexities but if you have a depreciation report, is it as simple as recalculating the net rent and taxable income for each year?

Cheers

A savvy investor should be able to do it. You have to fill in form NAT 2843-07.2006 from the ATO website (one for each year you are amending). For each year you will need a copy of the tax return you lodged for that year (which you should've kept) so that you can fill in which "question" you are adjusting (the question numbers for the same item can change year to year).

Note: There is an amendment period. You can only amend an individual income tax return up to two years after your notice of assessment (NOA) was issued for a tax year. e.g. If your 2006 NOA was issued on 1/11/2006, you can only amend this income tax return until 1/11/2008. As such you won't have to amend very many returns at all. (However, if you received trust/partnership distributions, the period is four years).

 

[WillG]

A savvy investor should be able to do it.

Thanks for the info. Looks straight forward.

so ... depreciation from 3, 4 and 5 years ago cannot be claimed anyway because amendments can only be made up to two years after the notice of assessment.

so ... does the amendment mean it cannot be claimed against income in the current year? this would mean my calculation for income in the current year is wrong.

mmm ... the joys of a simple tax system

 

[TheDoctor]

Thanks for the info. Looks straight forward.

so ... depreciation from 3, 4 and 5 years ago cannot be claimed anyway because amendments can only be made up to two years after the notice of assessment.

so ... does the amendment mean it cannot be claimed against income in the current year? this would mean my calculation for income in the current year is wrong.

mmm ... the joys of a simple tax system

Correct. You cannot claim prior year deductions in the current year. You just miss out. In practice though, if the adjustment were small ($100 - which this would not be) you probably would just stick it in this year. However, a refund would be issued for the amended years.

As the returns from 3-5 years ago cannot be amended, Lacasa doesn't have to reduce his cost base those years.

Yeah, that's why us accountants bill you so much. To make matters more complicated, you can't claim capital works deductions for the cost of removing the old building, only for the cost of building the new ones.

 

[Lacasa]

Thanks all,

Time to book a meeting with my account!

Cheers
Lacasa