Understanding “Tax on mere realisation of a capital asset”

A capital asset is something that you acquire with the intention of holding it and generating a return from it and not for the purpose of profit-making by sale. For example, a residential or commercial property that you hold for a period and rent would be considered a capital asset, irrespective of whether you renovate it or not. A capital asset would also extend to land that you purchase and then develop and rent when complete. You can see that the definition centres around the ‘hold’ strategy, rather than selling in the short-term.

A ‘mere realisation’ refers to the gain you make from a capital asset. If you eventually decide to sell the property that you purchased, held and rented for a period of time (as described above), and there was a profit due to a natural increase in value, this would be considered to be a mere realisation.

If, on the other hand, you bought a property with the intention of renovating it and selling it for a profit, that would be considered to be a profit-making transaction or scheme (which I’ll cover separately).

A mere realisation will be on the capital account, so you could access capital gains tax (CGT) concessions as a result.

CGT applies to any asset acquired after 20 September 1985, unless specifically excluded, such as your family home, car and other personal assets. Assets depreciated in a business are also excluded from CGT as they are counted against your revenue. As an Australian resident, CGT applies to all assets owned anywhere in the world. As a foreign resident, CGT applies to all taxable Australian property.

While you may be subject to CGT as opposed to income tax for any profits or gains made in a property development, you may be eligible for tax concessions.

For instance, if the asset was held in the name of an individual, trust or superannuation fund for more than 12 months, you are entitled to a CGT discount – 50 per cent for individuals and trusts and 33.33 per cent for superannuation funds. Therefore, you can potentially half your profit or gain if the asset is held in the right entity.

In other words, if you were to make a capital gain of $200,000 and you held the asset in your individual name or in a trust, you would be eligible for a 50 per cent CGT discount. Therefore, you would declare $100,000 as net income in your tax return and pay tax at your marginal rate (individual) or the marginal rates of the respective beneficiaries (trust). The highest rate of tax you would pay is currently 49 per cent inclusive of Medicare levy, or a total of $49,000.

How do you know if your sale is going to be considered on capital account?

The courts place a significant emphasis on your intention at the time you purchase an asset and whether your intention is to sell the asset for a profit, or whether your intention was to hold the asset for a longer-term purpose. As mentioned earlier, if an asset held for a longer-term purpose was then sold, the profit would be due to natural increase in value.

An example of the mere realisation of a capital asset is as follows:

Mr Pipe operated his plumbing business as a sole trader. With some savings for a deposit and available equity in his own home, he decided to purchase a residential property as an investment and rented the property for three years. Mr Pipe then sold the property at a large profit when property values had greatly increased. Mr Pipe’s profit is not income because the purchase and eventual sale of the residential property, in this scenario, is not considered a business operation. It was the purchase and sale of an investment, irrespective of whether he had a significant purpose of profit-making in the long-term.

Your activity regarding the asset will ultimately determine the tax treatment. The little you do and/or the longer you hold it, the more likely it will be considered a capital asset and therefore any gain considered a mere realisation.

If you need some help determining what, why or how regarding any investment you may hold or wish to hold, feel free to contact us.

Taxation issues for property developments

There are many tax and legal issues when dealing in the property development space.

It can be a potential minefield.

Fortunately, by understanding the lay of the land you will be in a much better position to protect yourself, or to ask your accountant or financial adviser the right questions to prevent you from being caught out by the ATO.

The key issue for property developments is the distinction between capital and revenue.

Why?

Put simply, there are different tax treatments for each revenue type, and any profits or gains that can be considered capital can receive significant tax concessions as opposed to those that are considered to be revenue.

The tax consequences arising from any property development fall into three categories:

  1. The mere realisation of a capital – refers to the gain you make from a capital asset. If you eventually decide to sell the property that you purchased, held and rented for a period of time (as described above), and there was a profit due to a natural increase in value, this would be considered to be a mere realisation.
  2. An isolated profit-making transaction or scheme – unlike a mere realisation of an asset’s value, a profit-making transaction is one where an asset was purchased with the intent of selling it for profit. This transaction is considered revenue, rather than capital (even if it’s an isolated or one-off transaction).
  3. Income from carrying on a business – your property development is considered to be a business where you have a history of property development (i.e. more than one development).

That is a very brief description of the three main categories, however, you can see that the ATO will look to place your property transactions into one of these categories and tax it accordingly.

We cannot stress enough the importance of understanding the three different transactions BEFORE you commence any property development related activity.

Doing so, we ensure that you have done everything to minimise the tax consequences so you can generate the best possible after-tax income.

If you are considering undertaking a property development and are unsure about which category you might fall into, then please contact us before you start.

If you have commenced a development, there may be opportunities to maximise your benefit, so again, please get in touch if you’re unsure.

#BuildIt

 

The Top six questions that I receive from business owners in the lead up to 30 June Tax Year End – Question #6

Top Tax Question #6 – What can I do to reduce my tax?

Short answer: Numerous options

Detailed answer: Tax planning is a very beneficial tool for business owners and is a very proactive way of minimising your tax liability. There are many options available, although not every option may be available to your particular situation. Examples of some are: defer sales income to post 30 June; pay all known business expenses before 30 June; bring forward any expenses that would otherwise be due post 30 June; pre-pay interest on business/investment loans; write-off any bad debts; purchase business assets (where required) and receive accelerated depreciation; contribute to superannuation up to concessional cap. There are many more which need to be considered in order to provide you with the all available strategies to minimise your tax.

If you would like further clarification or have any other questions, please do not hesitate to ask us.

Did you know that I’m releasing my book on Business Financial Management to help businesses cross the chasm of Tax rules and laws to grow their lifestyle business? Take a look at www.buildit-book.com.au to find out when it comes out!

The Top six questions that I receive from business owners in the lead up to 30 June Tax Year End – Question #5

Top Tax Question #5 – I have taken out $200,000 from my company account. Will that affect my tax?

Short answer: Yes

Detailed answer: Any money you take out of your business must be accounted for. If you have personally taken money, then it will need to be treated one of two way: (1) as personal income to you, or (2) as a Director’s Loan which will be repaid by you back to the company. Where option two is not viable or indeed not intended, then it will count as personal income to you. This can be in the form of Salary/Wages, Directors Fees or Shareholder Dividends. The first two will attract income tax at individual rates, i.e. Tax on $200,000 at current rates is $67,632 (assuming no other income or deductions). If you treat it as a Dividend, it will depend on whether you can issue Franked Dividends or Unfranked Dividends. Franked Dividends are when your company has already paid tax on prior earnings and therefore you can get a credit for that tax which has been paid relevant to the $200,000. The net tax payable by your personally in this example would be $23,917 on current rates.

If you would like further clarification or have any other questions, please do not hesitate to ask us.

Did you know that I’m releasing my book on Business Financial Management to help businesses cross the chasm of Tax rules and laws to grow their lifestyle business? Take a look at www.buildit-book.com.au to find out when it comes out!

The Top six questions that I receive from business owners in the lead up to 30 June Tax Year End – Question #4

Top Tax Question #4 – Will I reduce my tax if I pay out my business/investment loan?

Short answer: No

Detailed answer: Any business or investment loan will attract interest. The ATO also expect that loans provided at non-arm’s length (i.e. by Directors/Shareholders and/or their family or friends) would also attract interest (ATO Benchmark Rate). Given this, it is the interest on the loan the is 100% tax deductible, not any principal repayments. Therefore, paying out a loan (i.e. principal) will not reduce your tax. The tax-effective strategy would be to pre-pay interest, which is something you could arrange with your bank. It brings forward interest and therefore increases your tax deduction and reduces your tax.

If you would like further clarification or have any other questions, please do not hesitate to ask us.

Did you know that I’m releasing my book on Business Financial Management to help businesses cross the chasm of Tax rules and laws to grow their lifestyle business? Take a look at www.buildit-book.com.au to find out when it comes out!

The Top six questions that I receive from business owners in the lead up to 30 June Tax Year End – Question #3

Top Tax Question #3 – Should I pay some money into my superannuation?

Short answer: Yes

Detailed answer: You can contribute money into your superannuation by either concessional contributions (i.e. tax deductible) or non-concessional contributions (i.e. non-tax deductible). Concessional contributions are made from your business and are 100% tax deductible up to the contributions cap, which from 1 July 2017 is $25,000. If you utilise this cap and contribute the full $25,000, you will reduce your tax by the relevant income tax rate you are liable for. In other words, if you are a small business for income tax purposes, you will now pay 27.5% company tax on your taxable income, therefore if you contribute $25,000 in superannuation, you will reduce your income tax payable by $6,875. Please note that any concessional superannuation contributions are taxed going into your superannuation fund at 15% ($3,750), therefore your overall tax saving in this example will be $3,125. The added benefit is that you now have $21,250 invested wisely and generating a you more money.

If you would like further clarification or have any other questions, please do not hesitate to ask us.

Did you know that I’m releasing my book on Business Financial Management to help businesses cross the chasm of Tax rules and laws to grow their lifestyle business? Take a look at www.buildit-book.com.au to find out when it comes out!

The Top six questions that I receive from business owners in the lead up to 30 June Tax Year End – Question #2

Top Tax Question #2 – If I buy a vehicle, will that reduce my tax?

Short answer: Yes

Detailed answer: The cost of the vehicle used for business and acquired by the entity which operates your business, will be able to claim a deduction for depreciation of that vehicle. If the cost is greater than $20,000 net of GST, then the normal depreciation rules will apply. The standard depreciation rate for a motor vehicle designed to carry less than 1 tonne is 25% on Diminishing Value. For example, if you purchase and receive delivery of a $50,000 (net of GST) Ford Ranger on 15 June, you will be able to claim depreciation for the $50,000 at 25% pro-rata for the days in the year held for use, i.e. 15 days. In other words, $50,000 x 25% ( $12,500) divided by 365 days times 15 days (4.11%) equals $514 (rounded). Multiple this by your income tax rate (say, 27.5%), that gives you a tax saving of $141 for a $50,000 motor vehicle purchase in the first year. The greater benefit will be seen in year two when you have a full year of depreciation.

If you would like further clarification or have any other questions, please do not hesitate to ask us.

Did you know that I’m releasing my book on Business Financial Management to help businesses cross the chasm of Tax rules and laws to grow their lifestyle business? Take a look at www.buildit-book.com.au to find out when it comes out!

The Top six questions that I receive from business owners in the lead up to 30 June Tax Year End – Question #1

Top Tax Question #1 – Will I get a $20,000 refund if I buy an asset for my business?

Short answer: No

Detailed answer: The ATO allows small businesses to claim an immediate depreciation deduction for assets which cost no more than $20,000 (net of GST). Your business must qualify as a small business entity, that is one with an aggregated turnover over less than $2 million. Assets must be paid for and ready for use by 30 June. You can purchase numerous assets at or below the $20,000 threshold. Of course, the assets must be assets used solely for the business. Having qualified for this depreciation deduction, your will reduce your taxable income by the cost of the asset and therefore reduce your tax by the relevant income tax % you are liable for. In other words, if you are a small business for income tax purposes, you will now pay 27.5% company tax on your taxable income, therefore if you purchase and pay $20,000 for a business asset, you will reduce your income tax payable by $5,500. Not $20,000, but still, a deduction not to be sneezed at.

If you would like further clarification or have any other questions, please do not hesitate to ask us.

Did you know that I’m releasing my book on Business Financial Management to help businesses cross the chasm of Tax rules and laws to grow their lifestyle business? Take a look at www.buildit-book.com.au to find out when it comes out!

Tax Tips for Small Business

Tax tips for small business

Small businesses (sole traders, partnerships, companies and/ or trusts with a turnover of less than $2 million) may be eligible for a range of tax benefits including immediate write off of assets costing less than $20,000, a 28.5 per cent company tax rate, simplified depreciation, capital gains tax concessions and accounting on a cash basis.