In recent years, real property owners have been subject to a number of significant legislative changes. Changes to the taxation of real property has been in response to a number of factors, including housing affordability, tax avoidance and the impact that foreign ownership has had on the Australian property market.
In this tax update, we summarise the following issues impacting real property owners:
- Restricting tax deductions available for vacant land owners;
- GST on the sale of new residential dwellings;
- Clearance certificate requirements on settlement of real property transactions;
- Acquiring dwellings from a deceased estate – new guidelines on the main residence exemption;
- Specific changes impacting non-resident owners, including:
– Proposed changes to the CGT main residence exemption; and
– Vacancy fee for foreign owners of residential dwellings.
1. Restricting tax deductions available for vacant land owners
Currently, taxpayers may claim deductions for costs incurred in holding vacant land where that land is held for the purpose of earning assessable income or in carrying on a business. These costs include interest on borrowings, land taxes, council rates and maintenance costs.
However, as part of the 2018/19 Federal Budget, the Government was concerned that some taxpayers are claiming deductions for costs associated with holding vacant land where it is not genuinely held for the purpose of earning assessable income.
To combat this, proposed legislation is currently before the Senate which in essence restrict non-business entities such as individuals, family trusts and SMSFs from negative gearing on their vacant land investments from 1 July 2019 unless the vacant land is used or held available for use for the purpose of carrying on a business (such as property development of primary production) conducted by either:
- The vacant land owner; or
- An affiliate, spouse or child of the vacant land owner; or
- Certain ‘connected entities’ of the land owner or its affiliates.
These rules however do not apply to vacant land owners that are a corporate tax entity, superannuation plan (other than a SMSF), managed investment trust, public trust, or certain unit trusts or partnerships.
As such, many private vacant land owners who are not running a business (e.g. where vacant land is held with the intention of constructing rental properties) will no longer be entitled to claim deductions for their land holding costs from 1 July 2019.
In the ‘plain vanilla’ scenario of Mum and Dad taxpayers purchasing a vacant block of land with a view to build a new rental property, under the current rules, the holding costs would be deductible, as there is a clear intention to earn assessable income in the future.
However, under the proposed changes, Mum and Dad will no longer be able to claim these holding costs (e.g. interest on borrowings) until the rental property has been constructed and legally available for occupation and available for lease. Any costs incurred during the planning and construction phase and even prior to receiving an occupancy permit will no longer be deductible under the new changes.
Because of the definition of ‘vacant land’ which requires that a ‘substantive permanent building’ or ‘substantive permanent structure’ be on the land (both of which are defined terms), there is a risk that where a residential property is being unoccupied during periods of renovation, the property may fall within the definition of vacant land and holding costs associated with the property will be denied for that period. The proposed law is currently silent on this scenario.
Importantly, these new rules will apply regardless of when the land was purchased and there is no grandfathering of vacant land assets acquired prior to the Federal Budget announcement. Further, there is no Commissioner discretion to waive these rules.
- If you hold vacant land or unoccupied residential dwellings, consider how these proposed changes will impact your 2019/20 tax return;
- Maintain detailed records of all holding costs during the vacancy period, including documentation supporting when and if the land is used in carrying on a business; and
- Seek advice if you are unsure whether the buildings and structures on your land meet the required tests under the proposed changes in order for the property to not be defined as vacant land.
2. GST on the sale of new residential dwellings
Changes were made to GST laws last year which now require purchasers of new residential dwellings (being dwellings not previously sold as residential premises) or newly subdivided land to pay a GST directly to the ATO as part of the settlement process.
However, these rules impact not just new residential dwelling vendors, but all residential dwelling vendors and suppliers, as they are now required to provide a written notice to the purchaser prior to settlement to advise whether the sale is subject to GST withholding and whether the margin scheme applies. Significant penalties may be imposed where the vendor and supplier fails to provide this written notice to the purchaser.
- If purchasing new residential property or newly subdivided land, be aware of any new acquisitions post 1 July 2018 and your GST obligations;
- Land developers should be aware of the cashflow impact where relying on the margin scheme under these new rules.
For further information, please click here to view our previous article on this topic
3. Clearance certificate requirements on settlement of real property transactions
As part of the Foreign Resident Capital Gains Withholding Tax (FRCGW) rules, Australian resident vendors are required to obtain a clearance certificate from the ATO prior to settlement.
Where a clearance certificate is not obtained, the purchase of the real property is required to withhold 12.5% of the purchase price at settlement, where the real property has a market value of $750,000 or more.
Where the purchaser withholds the 12.5% tax, this amount is not a final withholding tax and the vendor can claim a credit for part, or all of the amount withheld at settlement on lodgement of their tax return for the relevant year.
- When buying and selling real property above the $750,000 threshold, consider your CGT withholding obligations and ensure that clearance certificates have been obtained prior to settlement. Where the vendor is a foreign resident or a clearance certificate has not been provided to the purchaser, the purchaser is required to withhold 12.5% of the purchase price to the ATO.
For further information, please click here to view our previous advice on this topic.
4. Acquiring dwellings from a deceased estate – new guidelines on the main residence exemption
Most taxpayers are aware that if they dispose of a dwelling that is their main residence and it is not used to produce assessable income, any capital gain or loss is disregarded under the CGT main residence exemption.
This exemption also applies where an individual inherits a dwelling from a deceased estate which was the deceased’s main residence, and the individual disposes of the property within two years of the deceased’s death. However, the Commissioner has the discretion to extend this two year period in certain situations.
The ATO has recently released a Practical Compliance Guideline which details when the Commissioner’s discretion will be exercised and provides a safe harbour for taxpayers. Where the safe harbour conditions are met, the individual may lodge their tax return as if the Commissioner had exercised his discretion.
Broadly, the safe harbour conditions outlined in the Guideline are:
- During the first two years after the deceased’s death, more than 12 months was spent addressing:
- Either the ownership of the dwelling or the will is challenged;
- A life or other equitable interest given in the will delayed the disposal of the dwelling;
- The administration of the deceased estate is complex and delayed the completion of administration; or
- Settlement of the contract of sale of the dwelling is delayed or fell through for reasons outside your control.
- If you have inherited real property under a will, consider if the main residence exemption will apply to you where you intend to sell the property;
- ·Seek tax advice where the sale is more than two years after the death of the deceased, to consider if Commissioner discretion to access the main residence exemption is likely to be granted and whether you can rely on the new safe harbour.
5. Specific changes impacting non-resident owners
a. Proposed changes to exclude main residence exemption
Under the current tax law, both Australian and foreign resident individuals may access the CGT main residence exemption where the dwelling was previously their principal place of residence prior to the sale of the dwelling.
As part of the 2017/18 Federal Budget, it was announced by the Turnbull government that changes should be made to the CGT rules so that foreign residents will not be entitled to claim the exemption where their main residence is sold.
The bill containing these changes was then introduced to Parliament, however it lapsed when the 2018/19 election was called. At this stage, a new bill has not yet been reintroduced. However, in the coming months we expect to see these CGT main residence rules be tightened as previously announced by the former Liberal government and fresh proposed changes drafted.
b. Vacancy fee for foreign owners of residential dwellings not residentially occupied
One area that has not received much air time is the vacancy fee which applies to foreign owners of unoccupied residential dwellings.
This fee applies to dwellings that not residentially occupied or rented out for more than 183 days in a ‘vacancy year’ and is payable on lodgement of a vacancy fee return. The vacancy fee is generally the same amount as the foreign investment application fee.
A foreign resident owner of a residential dwelling must lodge a vacancy regardless of whether the dwelling has been occupied or made available for rent where:
- The foreign resident made a foreign investment application for residential property after 7.30pm AEST on 9 May 2017;
- The foreign resident owner purchased the dwelling under a New Dwelling Exemption Certificate that a developer applied after 7.30pm AEST on 9 May 2017.
- In order to meet the definition of residentially occupied, for at least 183 days in a vacancy year:
- The owner or a relative of the owner must genuinely occupy the dwelling as their residence;
- The dwelling must be genuinely occupied as a residence subject to a lease or licence for a minimum term of 30 days; or
- The dwelling must be genuinely available as a residence on the rental market with a minimum term of 30 days.
Importantly, this would exclude short term rentals such as AirBnB rentals.
For those interested to learn about the above changes in more detail and the traps to avoid in practice, do not hesitate to contact your Cooper Partners client engagement team.