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Thank you for your excellent website.
My wife and I have an inner city 3 bedroom rental property (in joint names) that fortunately has risen in value over the years since we bought it in 2004.
At one stage we had plans approved to turn the 3 bedroom house into a 2 bedroom dwelling and build an additional 2 units on the site.
A few years ago we took these plans up to the stage of building approval, stopping just short of submitting them for approval , for a few reasons, including financial merits of the plan and loss of any possible parking, either onsite or offsite.
We did, however, have the planning approval extended, in case we changed our mind. This extension is valid until the end of this year.
Our intention had been to sell the property this year, buy an apartment and have a few hundred thousand dollars left over.
However, recently our daughter proposed that between us we develop the property with different plans, achieving a 3 bedroom house which would become our daughter’s principal residence and just one, one-bedroom unit to suit our personal needs (unlikely to be our principal residence, more "city pad" for us).
Without having yet embarked on a new planning process, I envisage that the parking arrangements for these properties (both parties would park under our unit), would require strata titling rather than permitting a subdivision of the property into 2 discrete components.
Our final property arrangements would need to be discrete, with our daughter owning the title to her house and car-parking space/s, and my partner and myself owning the apartment and other carparking space.
We would obviously wish to somehow achieve a pooling of our resources and undertake the process in a manner that is the most cost-effective (including most tax minimising) for both parties.
This proposal raises a number of questions that we need to consider prior to beginning any serious discussions with our daughter regarding this.
We need to understand our comparative financial positions under a number of possible scenarios.
They are:
1. If we went ahead and just sold our property on the market soon, as originally planned, would we be able to include the not inconsiderable costs of the initial planning exercise as capital expenditure, to help lower the capital gains tax payable, even though we didn’t end up undertaking the development (it would seem it may be a value add for a prospective buyer, particularly while the planning approval is still in place)?
We hope for a joint capital gain of $1M.
By the way, my wife and I are both at the point of retirement.
2. If the answer to the above is yes, would it still be yes after the planning approval had expired (it proves that planning approval can be achieved for that inner city block of land)?
3. If we decided to develop the block with our daughter along the new lines described above, we are unsure of the best point at which to sell the property to her to maximise the value of our collective dollars.
A. Were it possible to achieve a subdivision (which, given carparking title requirement, isn’t as straightforward as chopping in two), it would seem we would be likely to pay less capital gains tax on a property of lesser value than the whole property had originally been worth. And again, would the cost of the original planning process be able to be used to minimise our capital gains tax (on the basis that it was the first part of what has proved to be an evolutionary planning process)?
B. BUT, once we sell to our daughter, I assume her building costs all come from her post-tax dollars. This therefore suggests that there would be more merit in not selling to her until the building of her house is completed, since we would achieve many more deductions from our own CGT liability.
Presumably if we go down the path of B. building and then selling to our daughter, a bank will not lend any money to her until there is something in her name. This makes financing the building of her house a little tricky as we would have hoped to use her bank loan to help finance the build (she has at least 20% deposit, but if she threw that deposit money into supporting the build she then doesn’t have it as her deposit when she approaches the bank for a loan).
This is not insurmountable (though problematic).
My wife and I could potentially find the resources to do the build (possibly including extending the loan that currently exists on the property, though scratching together non-loan cash may also be possible).
We could potentially hold off on building our own unit until we realised the cash from the sale to our daughter (though we wouldn’t want to lose any cost-efficiencies that may derive from building them together).
I realise this latter is all a bit specific for you and more a matter for us to flesh out, but I just wanted to put you in the picture about it in case there is anything about our proposed approach and pooling of resources from all parties that the tax man might not like and in case there’s something that jumps out at you that we haven’t thought of as an option.
Answer
The following factors make the decision clearer
Section 118-42 ITAA 1997 allows a rollover relief (no CGT Event) when co owners of a property strata plan it and take individual ownership of a unit. Great example in this private ruling https://www.ato.gov.au/rba/content/?ffi=/static/rba/content/17485.htm This does not apply when subdividing.
The cost base of an asset includes any costs intended to improve it. Section 110-25(5) ITAA 1997:
(5) The fourth element is capital expenditure you incurred:
(a) the purpose or the expected effect of which is to increase or preserve the asset’s value; or
This section used to say that are still present in the property at the time of sale. That part has been removed so it is safe to assume that you can include the costs to date because you would not have incurred them if you had not intended for them to improve the value of the property. This would be the case even if they lapsed or changed.
The transfer to your daughter will be deemed to be at market value.
I assume constructing the house will improve the value of the property beyond the actual construction costs because you are creating two residence from one residence. If this is the case then even though you might get to include the money your daughter pays to construct the house in your cost base you would have a bigger capital gain than that increase in the cost base so it would be counter productive.
Capital gains tax and stamp duty on the transfer are going to be less if you pick the point in time when the value of the property is the lowest. I assume that is right now.
If you build your daughter’s house before transferring it to her you risk having to pay GST on the transfer value and only get the 50% discount on the gain up to the point the construction begins, after that normal business (of building) profit. Now I say risk, you do have some good arguments against this but I can tell you for sure that if you did that and sold the property to a third party GST and no 50% CGT discount would definitely be the case.
Now this is only a suggestion, obviously you need to engage an accountant to do the numbers and budgets. You will also need to consult a solicitor about section 118-42 ITAA 1997 (show him or her the ruling above) and work out how much of the current property you would have to sell your daughter to make sure this rollover relief works correctly. Also check with the solicitor that there would not be another round of stamp duty when the strata goes through. Oh and don’t forget a finance broker to check that the bank will give you the money to build. Now I would consider the following strategy:
Sell part of the property to your daughter now or maybe wait until you retire so you will be in a lower tax bracket for that capital gain. Super contribution is need to be discussed with your Accountant to decide the best time. Selling soon and before improving the property will minimise the capital gains tax you pay (you only have to pay for the portion you transfer) and the stamp duty she pays. The banks should be ok with this, she has the deposit and the collateral to put up, they will just want you and your wife to be co debtors. Together you borrow the construction costs and when it is completed you strata to give yourselves individual titles. Because of section 118-42 this will not trigger a CGT event.
