Lately, the ATO is taking a particular interest in scenarios where properties are renovated and then on-sold. In their view, you would likely fall into one of three possible categories:
- A personal property investor
- Engaged in a profit-making activity of property renovations
- Carrying on a business of renovating properties
They are especially concerned with the scenario where someone buys a property with the intention of carrying out renovations while living in the property and then selling the property once the work is completed (also known as “property flipping”).
Many taxpayers assume that any gain made from the activity will be exempt from tax as long as the property is their main residence for the entire ownership period due to the effect of the “main residence exemption”. However, this is not always the case as that only applies to situations in which a capital gain is made. If you renovate a property with the intention of selling the property again at a profit, you could instead be taxed on a simple profit-made basis in which case the main residence exemption is no longer applicable.
A summary of the three main scenarios and the general tax implications according to the tax office is as follows:
- Personal property investor – you acquired a property with the primary intention of using it as either a long-term rental investment or private residence. You undertake some renovations with the intention of either maximising your rental return or for lifestyle reasons. You subsequently find out the value of the property has increased markedly and you sell the property earlier than originally planned. You should generally be able to argue that the sale is dealt with on capital account rather than as a profit which means that the main residence exemption and/or CGT discount could apply. Note if you conducted a second renovation and re-sold based on the success of the first then the tax office is unlikely to see you as a personal property investor.
- Profit-making activity of property renovations – you acquired a property with the primary intention of completing a renovation and then selling the property when the work is completed. You complete the project in a well-organised and business-like manner. You are likely to be taxed as a profit with no access to the main residence exemption or CGT discount. This would apply even if you lived in the property for the whole period. GST may potentially be an issue also depending on how substantial the renovations are.
- Business of renovating properties – you undertake “property flipping” activities on a regular or repetitive basis and do so in a well organised, business-like manner. The properties would be treated in the same manner as trading stock with applicable costs largely not being deductible until each property is sold. Again, you are very likely to be taxed on a simple profit basis with no capital gains concessions being available. GST again may be an issue depending on how substantial renovations are.
The tax office has worked examples highlighting and emphasising each of these three categories which we can supply upon request. Note that the tax office receives property sale data from the Titles Office on a regular basis so they are often already aware of properties that taxpayers have disposed of before the tax year has even ended and they can also use the data received to identify patterns in property sales.
Make sure you’re aware of which category you fall into before undertaking property renovation activities to avoid nasty surprises down the track! Please contact us to discuss beforehand if you feel this may apply to you and you would like to clarify your position.
Jason Beare, Managing Partner
MBA BUSINESS SOLUTIONS
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