CGT on property sold from company to shareholders

Question

We bought a property for $350k in 1992.
We were intending to purchase under our joint names but on bad advice – very bad advice – we ended up creating a company (self and wife are the only share holders) and buying in the company’s name. It has already cost us around $50k (mostly as additional land tax) and will ultimately cost us around $200K – unless there is some way around taxation and state costs.
We had intended to subdivide and build but for various reasons it didn’t proceed and we put the existing house up for rent to help pay the mortgage on the property.
I am retired and my wife (aged 65) will probably retire within the next couple of years.
We have decided to put most of our superannuation into subdividing and building a pair of houses which should generate a net income of at least $60k per annum and continue to live as self-funding retirees. We own our own home (in my name only, bought 1973) and intend staying in it as long as we are fit enough handle the steps – then we will move into one of the new buildings and rent out our current home.
If we keep the company there will be an extra on-going yearly cost of over $7k and a CGT of $300k+ (in today’s $) when the company is ultimately broken up. We would like to dissolve the company to curb the financial haemorrhaging. To do this (as I understand it) we would have to sell to ourselves and pay a capital gains tax of about $110k (based on a third-party valuation) as well as about $28k NSW stamp duty.
• Can we use a sale price of about $470K (cf $740K valuation) so that after paying the CGT and returning our capital which was used to buy the property, the company has no assets or debts and can be closed down? This would save mucking around with paying ourselves dividends from the “profits” which would incur further tax costs because our individual marginal tax rates will be higher than the franking rate. Also what would the capital base be for the land we are “purchasing”?
• What are your thoughts on ownership after subdivision – separate individual titles or both as joint tenants? Hopefully, both properties will ultimately pass down to our children.
• Are there any avenues available to reduce the cost of changing the ownership of the property? Or to claw back some of the money?

Answer

Aaaah how frustrating. I am assuming the property is the only asset of significance in the company.
This is a huge question I am going to give direct answers but you must seek professional advice to work out the whole big picture for you.
If you transfer the property out of the company then it will be deemed to be sold at market value so the company will be up for CGT on the whole of the gain with no 50% CGT discount. If you are the purchaser then your cost base will start with the market value. About the only thing you did right was not to buy it until after 20th August 1991. This means you can use section 110-25(4) to increase the company’s cost base by absolutely anything associated with the property that you have not otherwise claimed as a tax deduction. Interest, rates, insurance, lawn mower fuel, fencing etc. When it was not rented out of course. Sounds like the company may also have carried forward losses from the years as a rental property, these will be useful to offset the gain. Crunch the numbers it may not be that bad. If you are going to change ownership the sooner the better ie lower valuation. The company can return your original capital to you with no tax consequences but first it must pay tax on the profit. You could then consider distributing it out slowly to yourself after retirement to utilise the franking credits from the tax paid while you are in a lower tax bracket. Alternatively, it could be returned to you on liquidation but that would be without the franking credits and still taxable to you as a capital gain on your shares so probably not a good outcome. One thing for sure, before you do anything you need to work with your accountant who has all the numbers to work out the best strategy, I can’t cover that here.
The decision you need to make is whether it is worth all the costs including stamp duty to do the transfer and for that matter whether you just sell it out right and buy something else. Buying something else would allow you to utilise a SMSF. Once you are going to go to the cost of transferring there is nothing to lose from buying something that suites you better. You are probably now regretting delaying transferring it years ago and, especially with improvements, don’t want to continue the exposure but if you never sell you never pay the tax and your children would just inherit the shares in the company. Nevertheless the tax bill will just grow and grow and erode the true value of their inheritance to the extent they may never really utilise that wealth for other purposes.
The best entity in which to own a property that you are going to develop and hold as a rental is a SMSF but you cannot transfer a property into a SMSF that you already own (directly or indirectly) unless it is solely used in a business. Secondly you cannot live in a property owned by your SMSF.
As your home is pre 1985 it does not need to be covered by your main residence exemption from CGT so it would be nice to cover one of the units you develop on this property. To do this you would need to own the property in your individual names either jointly or just one of you, not a trust. If you own them in a trust the trust can only operate for 80 years and then the assets must be distributed to the beneficiaries causing a CGT event and lots of tax. If you don’t think you have much risk of anyone suing you then the only real benefit of the trust is that you can choose who to distribute the income to each year. I gather that would just be you and your wife anyway so there seems no point in the extra cost and losing the main residence exemption on your unit. If you think your heirs would benefit from the property being held in a trust you can set this up as part of your will (if you transfer it into your personal name) and it can pass over to the testamentary trust without triggering CGT and at least then the 80 years time limit is further down the track.
I hate the idea of taking money from the nice tax free environment of super and investing it outside but as a couple you are allowed around $56,000 a year combined once you reach age pension age, tax free. It may even work out better to have some borrowings on the development and keep your money in super, again crunch the numbers.
You maybe able to get the company to contribute some of its profit on the sale into superannuation for you and it may qualify for a tax deduction for those contributions but again you need to speak to your accountant about this as there are many many issues to consider. There is also a work test you must pass if you before you can contribute to super past 65 years of age.

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