business or investment?

Question

Hi Julia

I’ve read the BanTacs booklets and notice boards regularly during the last few years and always find them packed with great info – the best on the web! Keep up the great work! Unfortunately I couldn’t find an existing answer to my current query so here goes…

My wife and I have identified a property which we feel has significant capital growth potential. The property is part of a Commercial development precinct, but has a house on it with an existing residential tenant. We would like to purchase the property in my wife’s name, keep it tenanted, and benefit from the capital growth by selling it in 5-10 years when the surrounding precinct has been developed by others. We do not intend to develop the property ourselves, just maintain the existing house as a rental.

We obtained the proposed purchase contract today and it states that the vendor is not registered for GST and that the sale price does not include GST. It also states that the buyer is not required to pay to the vendor any amount in addition to the purchase price for GST. My wife is not registered for GST as her current GST turnover is less than $75k.

As the gross rental yield is very low (around 1.5%) it is very unlikely it would ever be positively geared.

Q1: Would the property be deemed a business or an investment for GST and CGT purposes?

Q2: If GST applies then do we need to get the vendor to agree to the Margin Scheme so that GST is only assessed on the future capital gain?

Part 2
We are considering the option of purchasing the property in our existing Discretionary Family Trust. This trust is registered for GST and is used to stream PSI to my wife and I from consultancy services. It has a Corporate Trustee of which I am the sole Director.

Q3: Can we use the existing trust for this purchase or do we need a new one which is not registered for GST?

Thanks

Answer

Glad you are enjoying the web site, please spread the word.

Congratulations on asking these questions and before you buy!

As long as the contract does not have a going concern clause in it you have no GST concerns. Further, for the vendor to be allowed to use a going concern clause both the buyer and seller have to be registered for GST so it certainly looks like that contract is ok, at least re GST that is.

There is the risk that the value of the house is so low that the contract could be considered for vacant land but even then it will only be subject to GST if the seller is registered for GST or required to be registered. The latter is difficult for you to be able to evaluate so just to be sure make sure the contract does not have a clause in it saying that if at a later date the ATO decides GST is to apply then the purchaser has to pay extra. Without this clause any later GST liability will rest with the vendor and I would expect (not a solicitor) the clause you refer to, “that the buyer is not required to pay to the vendor any amount in addition to the purchase price for GST” would protect you.

SO moving on, knowing you are ok to buy without GST consequences, to the question of what happens when you sell. The main concern is whether you will have to charge GST when you sell. There is certainly a risk then that the house maybe so derelict or insignificant that the sale could be considered one of vacant land and as such subject to GST. To avoid GST under these circumstances you need to be not registered for GST and not required to be registered for GST. The former is simple enough if the owner of the property does not have any other activities that force it to be registered for GST. The second point about being required to be registered is a question of whether your primary purpose in buying the property was to profit from its resale ie the property is the trading stock of your business. If it is your trading stock then it is part of your annual turnover and it if your annual turnover is more than $75,000 of supplies subject to GST (ie vacant land) then you are required to be registered for GST. It sounds like you have been reading our How Not To Be A Developer booklet and understand about merely realising an asset. Even if the property investment only makes sense because of the potential capital gain the fact that you are not doing anything to the property just holding in the hope of selling for a good price in the future will keep the property from being part of a business turnover. For this same reason the gain will be subject to CGT so you will get the 50% CGT discount after 12 months.
In short as long as the owner of the property is not registered, or required to be registered, for GST at the time of the sale. You don’t go changing the property (be careful there are some interesting rulings on demolishing a property) and you do not try to use the margin scheme or apply GST when you sell. Then you will not have to charge GST when you sell.

Now to the margin scheme. This will only apply if the current owner of the property is registered for GST because otherwise GST would not apply anyway. The ability for you, the buyer, to later use the margin scheme is not limited to just properties purchased under the margin scheme. If the person who sold it to you is not registered for GST then you qualify to use the margin scheme because GST did not apply when you purchased the property. Of course this is only of concern if GST applies to your sale, which we are working on here to make sure it doesn’t.

So very very negatively geared. If a property is never likely to produce a profit from its income then the ATO is entitled to examine your motives for buying the property. They may discover that you have another purpose other than earning taxable income from holding the property and attempt to reduce your ability to negatively gear. This is an argument used to defeat hybrid trusts when someone else gets the benefit of the capital growth, not the person who got the tax deductions. In your case the capital growth is going to be received by the same person/entity so they should not argue this. If the property did not produce any income then they would argue it is held on capital account so no negative gearing. But as it is producing some income and the taxable capital growth justifies the investment and there is no other purpose ie not renting below market value to a relative, then you should have no trouble claiming the loss.

I would not recommend holding the property in the same trust as your business because anyone suing the business could access the property and vis versa. If you must hold it in a trust then a separate trust but make sure that the new trust is a beneficiary of the business trust so that non PSI business income can offset the negative gearing. Is there any non PSI business income? This is not to say I am recommending holding it in a trust in fact this could be a very bad move if there is no non PSI business income. I need to know a lot more about your circumstances before I could advise who should own the property, but also consider a SMSF. Whatever you decide this owner must not be registered for GST. In the case of your wife is there a risk that when you sell the property her GSTable turnover will be more than $75,000 so she would be forced to register? If this is the case you still have the argument that the property is not held in relation to the enterprise that is registered for GST but it maybe better just to avoid the potential argument.

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