Flipping properties can be an exciting and lucrative business opportunity. But making renovations to investment or rental properties is not the same as carrying out renovations for your own home. There are some major tax implications to consider, such as the Capital Gains Tax (CGT).
Let’s take a look at exactly what capital gains tax is and what it means for you.
What is Capital Gains Tax?
In its basic form, capital gains tax applies when you sell an asset that has gone up in value compared to when you purchased it. And because the whole point of property investment is usually to sell a property for a higher price than your purchase price, you’re often eligible to pay capital gains.
When you sell a rental or investment property, you’ll typically be paying capital gains on the net profit that you make from the sale. In most cases, the cost of renovations can be deducted before you pay the tax.
So if you purchased a house for AU$500,000 and then spent $50,000 renovating it before selling it for $650,000, you’d have to pay CGT on your $100,000 net gain.
How does CGT get calculated?
When a property is sold, CGT is worked out by subtracting the property’s cost base from the selling price to work out the net profit.
The cost base is essentially all the money spent on the seller’s home. Some of the categories that make up the cost base include:
- The initial purchase value of the property
- Legal fees during the initial purchase and during the sale process
- Stamp duty
- Agent commission
- Renovation costs
CGT is worked out at the end of the financial year with other tax obligations related to income tax. Therefore, property investors must fill out a specific section about their property assets on their income tax returns.
Main residence or investment property?
There’s an important distinction between main residences and rental or investment properties when it comes to CGT.
If you’re living in a property as a full-time resident, the property is eligible for a main residence exemption. This means that you won’t have to pay capital gain on any renovations that you make.
For tax purposes, it’s always best to declare your home as your main residence as soon as you acquire it. To be eligible for the exemption, the Australian tax office requires you to have lived on the property for a minimum of three months.
But if you have other property apart from your main residence that perhaps you rent out, that is classed as an investment property and is subject to CGT.
If you have more than one investment or rental property, CGT applies to each individual property. Assets like business locations, holiday homes, and vacant plots of land are subject to capital gains.
Repairs or Renovations
If you’re trying to work out CGT for a residential investment property or other property assets, there’s an important distinction to be made between repairs and renovations. Most property repairs, such as replacing broken windows or appliances, are exempt from CGT.
Renovations are classed as a capital expense because they increase the value of a property, whereas repairs maintain the value. As an investment in the property’s capital value, renovations count towards CGT.
When are repairs classed as renovations?
Although most repairs are considered to be exempt from CGT, the line between a repair and a renovation is a little blurred. This can have tax implications, so it’s important to be aware of these situations.
Repairs are only exempt from CGT if the replacement restores the damaged item back to its initial effectiveness. So a broken fridge would need to be replaced with a similar appliance, and if the replacement is a better version of the damaged product, that counts as a renovation.
The timing of repairs also needs to be taken into account. To be classed as exempt from CGT, repairs must be conducted while tenants are present in the building.
If you’re a landlord who’s recently purchased a new investment property, any repairs made before tenants move in are classed as “initial repairs”, which aren’t eligible for a CGT discount.
On the plus side, the grey area between renovations and repairs does have a few minor loopholes.
Some alterations that seem like renovations, such as repainting a room, are technically classed as repairs. Always check the Australian Taxation Office website to see what’s officially considered a repair or a renovation.
Which Renovations Class as Capital Gain?
Renovating properties is often a cost-effective way of increasing their value. However, performing renovations also have capital gains tax implications that must be accounted for when filling out a tax return.
To ensure that all your figures are correct, it’s essential to keep detailed records of any renovation work. This also helps you determine which changes are classed as renovations and which ones count as repairs.
Some of the most popular renovations include bathroom renovations, kitchen remodelling, and major extensions or layout changes to the building.
Renovations like these are eligible for tax benefits, which can be claimed on expenses such as renovation construction costs. Structural improvements are another capital works deduction.
How to Claim Capital Works Deductions
Capital works deductions act like CGT concessions, helping you to lower the amount you have to pay. This tax benefit covers major renovations and allows landlords to claim depreciation back on the value of these renovations.
Major building works like extensions or kitchen renovations can have 2.5% of their depreciation value deducted from CGT per annum for 40 years of the building’s life.
However, smaller renovations can often have a higher percentage of this value deducted, and these are usually things classed as fixtures and fittings.
Kitchen appliances, light fittings, and even the hot water service fall into this category. And if these fittings cost less than AUS$300, the value can be written off straight away.