Impact of Capital Gains Tax on Residential Property Investment Performance - Essay Example

The Impact of Capital Gains Tax on Residential Property Investment Performance and Viability in AUSTRALIA Executive Summary Capital Gains Tax (CGT) in Australia applies to the capital gain made on disposal of any asset, except for specific exemptions. The most significant exemption is the family home. Rollover provisions apply to some disposals, one of the most significant is transfers to beneficiaries on death, so that the CGT is not a quasi death duty. CGT operates by having net gains treated as taxable income in the tax year an asset is sold or otherwise disposed of. If an asset is held for at least 1 year then any gain is first discounted by 50% for individual taxpayers, or by 33 1/3% for superannuation funds. Net losses in a tax year may be carried forward, but not offset against income. Personal use assets and collectables are treated as separate categories and losses on those are quarantined so they can only be applied against gains in the same category, not other gains. This works to stop taxpayers subsidizing hobbies from their investment earnings. (Wikipedia). This study will include the impact of CGT on Residencial Property Investment Performance and viability in Australia. Some organizations believe that because of this capital gains tax the increasing number of house affordability is alarming. Only a small percentage of family can now be able to afford houses. Instead they resort on renting it, still it is not that affordable to rent one. This high cost of housing is because of the capital gains tax in Australian. However to some investors it has a positive effect on their business. As we go along with this study we will able to see the effects of this capital gains tax both to the ordinary individual and to the business and investors. Capital Gains on Residential Property Capital Gain Tax as defined by Australian Taxation Office as the tax that you pay on any capital gain you include on your annual income tax return. It is not a separate tax, merely a component of your income tax. Your are taxed on your net capital gain at your marginal tax rate. All residential properties are subjected to capital gains tax. To those family that owns one or more properties the capital gain tax is complicated for them. Even if they uses the name of their spouse the said property is still subjected to capital gain tax. The Construction, Forestry, Mining and Energy Union - Construction and General Division, the CFMEU believes that Australia is in the grip of a housing crisis. This crisis is not only characterized by declining affordability in first home ownership, but by increasing levels of housing stress among low to middle income participants in the private rental market, the degradation and running down of public housing stock across Australia, and finally, by growing levels of homelessness in the community. The Union believes that this trend comes at a time when a select few have grown more and more wealthy off the back of a speculative boom in house and land prices, that serves to make the already well off even more affluent, while locking many ordinary Australians out of home ownership, and affordable rental housing. The Union bases its view on several important studies over the recent period, including work done by the Affordable Housing National Research Consortium, of which the Union was a part. However there are still residential properties which are exempted in the tax. This may have a positive effect to those who owns only one property but to some who has 2 or more property the capital gains tax is a burden for them. Impact of Capital Gains Tax to Residential Property in Australia As per described above one main impact of capital gain tax is the increasing number of non-affordability of renting and owning a house. Confusion on the application of the capital gain tax is also another reason of this. There are cases where in the property is not subjected to capital gain tax because of some exemptions which are further discuss in this paper. Factors Determining Application of Exemption The following factors are taken into account by the Taxation Office in determining whether or not a residence qualifies for CGT exemption as a sole or principal place of residence: the length of time the person has lived in the residence; the address to which a person's mail is sent; the place of residence of a person's family; whether or not a person's belongings are kept at the residence; the person's address on the electoral roll; the person's intention in occupying the residence; and the connection of services and utilities such as telephone, electricity and gas. It should be noted that the mere intention to occupy a dwelling as a sole or principal place of residence without actually residing in the dwelling will not be sufficient to procure the exemption. Reflecting a recovery from possibly Australia's worst drought in 100 years and an improvement in the global economy, Australian activity has picked up significantly since mid 2003. Looking ahead, Australian growth is expected to be quite strong at around 4% in 2004. Exports are expected to continue a gradual recovery, while domestic demand is forecast to moderate significantly. Higher interest rates and reduced wealth gains are expected to see dwelling investment contract moderately and consumption growth soften during 2004. Also underpinning economic forecasts are an easing in business investment growth and ongoing strength in public spending. After reaching a 15 year high in late 2003, it expects credit expansion to moderate to a still solid pace in 2004, reflecting largely an easing in household demand. Subsequent to increasing the cash rate by 50 bps, the Reserve Bank of Australia has kept the cash rate unchanged at 5.25% in early 2004, due to tentative signs of cooling in property markets and the marked strengthening of the $A to a 7 year high in early 2004. The Group expects the Reserve Bank of Australia to increase the cash rate moderately further during 2004, as the global recovery continues, housing activity cools and the $A eases. The above shows the effect of the capital gain tax in the residential business. (National Australian Bank Ltd). What If You Own More Than One Residence Where a person owns and lives in two houses, difficulties can arise in determining which of the houses is exempt. This problem typically arises when a retiree begins to spend more and more time in a holiday home. Such factors as those noted above regarding whether or not a residence is exempt as a sole or principal place of residence will influence the outcome. The matter is a question of fact. It may be thought that these problems could be easily over come by purchasing one house in a husband's name and the second in the wife's name, both then claiming the exemption. Unfortunately, such is not the case. The legislation contains nomination provisions that have the effect of limiting this exemption as well as preventing the exemption being applied to a child who is under 18 and dependant on a person for economic support. The very nature of the sole or principal place of residence exemption implies the existence of a residence in which a person lives. However the legislation extends to cover situations where a person:- builds a dwelling to live in on a vacant block of land; or completes the erection of a dwelling; or builds a dwelling after demolishing an existing or partially completed dwelling; or repairs or renovates a dwelling. In these cases a person may claim an exemption provided that the person resides in the dwelling for at least three months and the time from acquisition to completion of the work is less than four years. In the event that the person owns an existing residence during the construction period an election should be made. On occasions, a person may cease living at their sole or principal place of residence. When this occurs the person may elect to have this residence continue to be treated as their sole or principal place of residence. If the residence is used for income producing purposes, such as deriving rental income, the exemption runs for a period of six years. After six years any capital gain is assessable on a pro rata basis. This concession has particular application in situations where work requires a temporary or extended relocation. Another situation which may arise is where timing differences between the purchase of a residence and sale of an existing residence may result in a person having two residences. The legislation allows an exemption from CGT for both residences for up to three months, provided the residence being sold was the persons sole or principal place of residence for a continuous three month period during the previous twelve months up to its sale, and during this twelve month period it was not used to produce assessable income. Issues Determining Liability to Capital Gains Tax There are a number of issues that impact how the disposal or deemed disposal of an asset will be subject to CGT in Australia: The duration of the assignment to Australia How long the assignee has been resident in Australia in the 10 years preceding the end of the current assignment When the asset was acquired and when it was sold The nature of the asset acquired The individual's residence status in Australia at the date of disposal. Generally, any asset acquired before September 20, 1985, is exempt from CGT and therefore any capital gain or capital loss arising on disposal is ignored for these purposes. It is important to note that unlike many other countries, a nonresident of Australia may still be liable to Australian CGT if the asset is regarded as sited in Australia (e.g., land, shares in an Australian private company, etc.), and, generally, relief is not available under the relevant double tax treaty. Some exemptions from CGT are available. Assignees are most likely to be concerned with the exemptions governing the individual's 1) main residence and 2) investments in certain foreign funds-regarded as Foreign Investment Funds (FIF). The latter are basically collective investments located outside Australia, such as certain unit trusts in the United Kingdom. The amount of the tax that is imposed varies and actually depends on a variety of factors, which even include how long the seller has owned the investment/property as well as what type it is. The capital gains tax will not be asked for until the investment/property is actually sold. For instance, if the stocks in your portfolio have been appreciating in value, you can rest assured that you won't have to pay any type of taxes on them unless you have actually sold the stocks. Investors should also remember that unlike other taxes, the rate imposed on the capital gains tax is not fixed. The rate imposed will depend on how long the asset has been owned. A good example would be an asset that has been owned for less than year. The capital gains tax that will be imposed on the sale of this property will be at the same rate as an ordinary income. On the other hand, the tax rates that will be given on the sale of a property that has been in the possession of the owner for more than a year can end up being lower. An Australian capital gain of an individual shareholder resident in Australia is generally taxed at the individual's marginal tax rate. However, individual shareholders resident in Australia may be entitled to a 50% exemption if the ADRs or ordinary shares are held for more than one year. Where the shareholder is a superannuation fund, it may be entitled to a 33.33% exemption if the ADRs or ordinary shares are held for more than one year. When the exemption is applied by a taxpayer, no cost base indexation is available. Generally, Australian capital gains tax will not apply to shares acquired before 20 September 1985. However, an Australian taxpayer may still be subject to Australian income tax in respect of such a disposal in certain circumstances. Legislation recently introduced but not yet enacted in Australia provides for a capital gains tax exemption in respect of the disposal of shares in a foreign company where the shareholder has at least a 10% interest in the company. The exemption is prima face available to Australian shareholders for disposals occurring on or after 1 July 2004 to the extent to which the company in which the shares are held carries on an active business. Exemptions from CGT These include: 1) Principal residence owned personally and surrounding land (up to 2 hectares) which is not used for income producing purposes. One rule that you should remember is that in most cases you can completely avoid capital gains tax if the house that you are planning to sell is considered as your principal residence. In order for a house to be considered as the principal residence you must have taken residence there for two of the last five years. The two years imposed don't necessarily have to be sequential years or even the most recent two years. Just as long as you fulfill the two-year rule the government will consider the house your principal residence. In fact, you don't even need to be living at the house at the time that you sell your property. 2) Proceeds of superannuation and life insurance policies; 3) Certain motor vehicles; 4) Gains on certain personal use assets if acquired for less than $10,000; and 5) 50% of gain on disposal of business goodwill where net value of the business (and associated businesses) is less than $2 million (indexed) for disposals of goodwill after 26 February, 1992 Offsetting business loss Income or trading losses can be offset against realized capital gains either in the year in which the loss occurs or carried forward to be offset against future capital gains. Where capital losses are realized on the sale of post 19 September, 1985 assets (i.e. sales proceeds are less than original cost) these losses can only be offset against capital gains realized in the current year or be carried forward and offset against capital gains in subsequent years. Capital Gain Tax in Comparison with other Countries In Georgia they have this 1031 Tax Exchange which is a great money saving for investors. Investors must remember that when they sell a property, taxes are paid on the capital gains - not equity or profit. Therefore, understanding the allowable tax benefits under the Internal Revenue Code 1031 is vital to save money, create leverage towards future purchases and allow you to build wealth. The 1031 Tax Exchange essentially allows you to "sell" your investment property and "purchase" another investment property - all without paying taxes under the condition that you follow certain guidelines throughout the process from start to end.For Georgia the capital gains tax does not affect that much their investment in residential property as long as you know the 1031 Tax Exchange. Capital gains tax (CGT) was introduced in South Africa on 1 October 2001. CAPITAL GAINS TAX in South Africa applies to gains from 1 October 2001, in cases where assets were owned before that date and parted with after that date. The Income Tax Act specifies two methods to determine the value of the asset on 1 October 2001 The percentages of CGT in South Africa are as follows: for legal persons, 50% of their net profit will attract CGT and for natural persons 25%. This portion of the net gain will be taxed at your marginal tax rate. As an effective tax rate this means you will pay a maximum effective rate of 10% and corporate taxpayers a maximum of 15%. For example, for natural persons the maximum marginal tax rate is 40%. Assuming the aggregate capital gain for the year of assessment is R25 000, 25% of R25 000 is R6 250, which is taxed at 40%, therefore R2 500 is payable. The R2 500 as a percentage of the original profit made is 10%. Individuals and special trusts do not have to pay CAPITAL GAINS TAX on the first R10 000 of capital gains per year. In UK, tax rules governing capital gains tax (CGT) on the disposal of shares are complex and depend on the precise circumstances that apply in each case. It is not, therefore, possible to give individual advice to shareowners who are subject to UK CGT. For shares held on 31 March 1982 and continuing to be held by shareowners who are resident in the UK for tax purposes and are subject to CGT, the base cost for CGT purposes will normally be the market value of the shares as at 31 March 1982. For shares purchased after this date by shareowners, the base cost will normally be the acquisition costs of the shares. The value of an ordinary share of 12.5p as at 31 March 1982 was 49.25p, adjusted to reflect the two for one share split in 1999. For shareowners who subscribed for their full entitlement under the rights issues in October 1993 and February 1995, the value per share was 77.535p. Conclusions Capital gains tax can be a burden for some of the residents in Australia. However better understanding of the conditions on how you can be able to enroll your property for an exemption would help you in gaining a profitable income in property investment. It is the concern of every Australian resident to be able to know if their properties are exempted or not. Coordination with the government concerning the matter of your tax in your property would help you clear some of your question. Reference: 1. Guide to Capital Gains Tax 2006, Australian Taxation Office, p. 8 . 2. Australian Housing and Urban Research Institute for the Affordable Housing National Research Consortium, Policy Options for Stimulating Private Sector Investment in Affordable Housing Across Australia - Stage One Report: Outlining the Need for Action September 2001 3. The National Housing Strategy 1991, The Affordability of Australian Housing, Issues paper No. 2, p.30 4. Latham, Mark, Shadow Federal Minister for Urban Development and Housing, Institutional Investment in the Rental Housing Market: Research Briefing Paper, April 2003. 5. Productivity Commission, First Home Ownership Inquiry, Final Report March 2004 6. Reserve Bank of Australia, Submission to the Productivity Commission Inquiry on First Home Ownership, November, 2003 7. Australian Council of Social Service, Michael Raper, Presentation on Negative Gearing to Fairness and Services: Restoring the Integrity of the Tax System 23 June 2004 Sydney 8. Tax Central, Digita , www.digita.com/taxcentral/home/reference/savingtax 9. Capital Gain Tax http://www.bondonline.co.za/news.asp 10. National Australian Bank Limited NAB report http://sec.edgar-online.com/2004/05/12/0001104659-04-013839/section4.asp Read More