It’s the dream of everyone who ever spent too much time watching property makeover shows on TV; give up the day job and become a professional fixer-upper. The technical term for this is “flipping houses”; buy a renovator’s delight, do it up, sell and make a nice profit, then do it all over again with a different house. But what are the tax implications?
If you are regarded by the ATO as a property investor, the chances are that the profits arising from the sale of your property would be subject to Capital Gains Tax (CGT). You’ll make a capital gain where the capital proceeds on the sale exceed the cost base of the asset, which is basically the amount you paid for the property in the first place, plus costs of acquisition and sale (including legal fees, valuation fees, advertising, etc), the costs which you’ve incurred on any renovations and also the costs of insurance, rates and interest on borrowings. If proceeds are less than the cost base, you’ll make a capital loss, which can generally only be offset against other capital gains of the current year or future years.
The good news is that if you make a capital gain and have owned the property for more than 12 months, you can take advantage of the CGT discount to reduce your capital gain by 50%. The bad news is that if you’ve owned the property for less than 12 months before selling it, you’ll pay CGT at your full rate of tax.
To be deemed a property investor, you need to buy a property with the intention of renting it out. You might need to renovate the property in order to attract tenants but at the time you purchased it, you need to be able to demonstrate that the property was purchased for the long term. Provided the intention was to keep the property for capital growth, even if you ultimately change your mind and sell the property after doing it up, you’ll still be subject to CGT treatment.
If you buy a property with the specific intention of renovating and then quickly selling, the tax treatment will be different. Instead, the ATO will regard the transaction as a profit-making scheme and the profit or loss from the purchase, renovation and sale will need to be reported as income in your tax return. You’ll get a deduction for all costs incurred but you won’t be able to take advantage of the 50% discount (which only applies to CGT).
Some people like to move into the property they are renovating with a view to taking advantage of the CGT main residence exemption. Although it seems to me that there is a reasonable argument that if you’re actually living in the house as your main residence, the CGT rules apply (and hence the gain can be completely eliminated by the main residence exemption), this isn’t a view that the ATO agrees with. The guidance on their website is clear that they would regard this as a profit making scheme where the intention is to “flip” the house (even if you live there whilst the renovations are undertaken), so the CGT rules (including the main residence exemption) won’t be apply.
The other possibility is that if you have multiple properties under development at the same time, you might be treated as if you have a business of renovating properties. This means you’ll also be subject to income tax rather than CGT (and won’t be able to access the CGT discount). You’ll need to bring into account the proceeds of each sale but you’ll be able to offset the renovation costs, the cost of borrowings plus all the other “costs of business” which you incur. If you make a loss, you’ll normally be able to offset that loss against any other income or gains in the year. You may also be required to register for GST if the renovations are substantial.
And finally, don’t forget Stamp Duty. Every state has different rules around Stamp Duty but one thing you can rely on is that every time you purchase a house, you’ll need to budget to spend thousands of dollars settling the Stamp Duty liability and the more you flip, the more often you’ll pay. In Victoria, for instance, Stamp Duty on purchasing a $500,000 house will leave you around $25,000 out of pocket (or a bit less if you live in the house as your place of residence), a cost that can easily eat into your profit margins, though note that you’ll get some relief by adding this cost to your CGT cost base.
Mark Chapman is the Director of Tax Communications at H&R Block.