“The more you know,
the more you know
Some things never change! It seems this gem is lost on a lot of people.
Beware of those who are so certain and willing to give advice, qualified or not!
Skip forward 2000 years, and there’s wisdom aplenty.
Adam Smith was a Scottish philosopher and is considered to be the founding father of Economics.
Adam was a fan of self-interest.
He believed it was the most powerful building block of the market system that ensured what people wanted, and at what price they were prepared to pay, was produced.
He was also an advocate of specialisation – doing one thing and doing it well and relying on others to do their bit, i.e. the ‘division of labour’,
In other words, we should become experts at what we do and let others do what they do well, and productivity gains and enhanced outcomes will be the result.
Now, while the intricacies and efficiencies of pin-making illustrated Adam’s treatise, 21st century folk with fingertip access to cognitive tools can be tempted to think they know everything about everything.
Aristotle would be shaking his head.
A recent Yale University study in the Journal of Experimental Psychology concluded that search engines and the overabundance of information they provide at the touch of a screen, are making us think we know more than we do.
A little information can be a dangerous thing. We probably all know someone who shouldn’t have access to symptomchecker.com!
“Searching the Internet may cause a systematic failure to recognise the extent to which we rely on outsourced knowledge,” the study said. “… People mistake access to information for their personal understanding of the information.”
This misconception is so apparent when it comes to investing generally and particularly property investment. Many people are easily influenced by the media, whose mission is to sell stories and bolster audience numbers and ratings. So their modus operandi is often to exaggerate, catastrophise and to disturb with misleading ‘half baked’ headlines and cherry-picked information. They also generalise. (remember the misnomer of the property market)
Being at a backyard BBQ seems to bring out the philosopher, politician and religious acolyte in many of us too…
It’s a notorious source of dubious investment advice, often from some who haven’t invested in their lives!
Sometimes it’s motivated by bad experiences, other times ignorance, other times fear and even by jealousy.
Making an investment property decision is an important one that should be made on the balance of evidence and qualified, professional advice, tailored to your particular circumstances, goals and preferences and importantly, your risk profile.
Taking control means deciding you want and need to create a better future, making a plan and then seeking support to implement it.
So, who are the team members you should gather around you and lean on?
A capital gain is a difference between
what was paid for an asset
and what it sold for
(with an allowance for costs of purchase and sale)
Introduced in 1985, Capital Gains Tax was part of a move to broaden the base of taxation in Australia. Previously, the income derived from the profitable sale of shares or a property investment was tax-free.
The situation was inequitable as some people were able to make an income and pay no tax at all.
Broadening the base of taxation involves collecting tax from a more extensive range of sources in the hope of raising more tax revenue (on previously exempt sources of income) and from more people.
The rationale behind the reform was that it was fair and equitable to make everyone pay a share of the tax revenue needed to support the government’s activities, including the public goods that all Australian’s benefit from regardless of their employment or income source. It also would make possible a reduction in the burden on PAYG income taxpayers, who constitute the majority of taxpayers.
CGT is not a separate tax – it is part of the income tax regime and is treated as such.
If you buy and sell an asset within 12 months, of 100% the gain (adjusted for inflation and costs) is added to your assessable income and tax is levied at your top your marginal rate.
However, as an individual, (company structures receive no discount and pay 30% CGT) if you have owned the asset for more than 12 months and then sell it and make a capital gain, you are entitled to a 50% discount on the amount on which the tax will be levied.
As part of the income tax system, the timing of any sale of assets is best done on the advice of your accountant. Choosing to sell an asset in a financial year in which your income is lower may assist in minimizing your CGT obligation.
Should you make a capital loss on the sale of an asset, the loss can’t be offset against your regular income but can be carried forward indefinitely to be used to reduce any future capital gain.
With property or other assets purchased in an SMSF, the tax rate is 15%, and the CGT discount is 33.3% (rather than 50% for individuals), but if you sell the property once you’ve retired (after 60), you will not be obliged to pay CGT at all.
Personal assets such as the family home, car, furniture etc. are exempt from capital gains tax.
The tax is an imposition on alternative forms of producing an income.
Remember that time in the market is most important when it relates to property investment. Given the significant entry and exit costs associated with a property, coming in and out of the market is a misguided and costly approach to what should be a long term strategy.
CGT is deferred until the sale of the property, and so property investors should never plan to pay tax on more than 50% of the capital gain. Timing becomes relevant when choosing when to sell – once again expert, and professional advice is imperative to take advantage of techniques to minimize your tax obligations legally.
Any tax will impose economic costs by influencing the decisions people and businesses make about how they work, save, invest and employ.
CGT is no exception. It may influence decisions to invest, which in turn may have broader implications for the economy, employment and growth. (remember the multiplier effect of housing construction!)
The government needs to tread a thin line between raising ample revenue, distributing the responsibility equitably across the community and the disincentive effects of tax liability. Any disincentive to invest or employ or spend will negatively affect tax revenues – think of payroll tax, income tax, GST, increased welfare payments etc.
In 1950 Australia’s tax law consisted of 1080 pages, today it exceeds 14000 pages!
Complex tax laws impose high compliance costs – time and money the community spends dealing with tax matters. The measure of a good tax is that it is simple, able to be complied with, fair and is as low as possible to avoid disincentives.
The Australian Treasury is encouraging community discussion about the need for ongoing reform and adaptation of the tax system to meet the challenges of a changing Australia.
Ownership may be divided
The decision about who will own the property and in what proportion is typically based around individual incomes and marginal tax rates, to maximise rebates and to minimise tax obligations.
However, it’s also essential to consider the future. One party to the contract may be the lower-income earner now, but their future earning potential may be very different. Depending on the time horizon of the investment; they may need to sacrifice some rebates now to benefit from more significant returns in the future.
Exit strategies should also be considered. Capital Gains Tax obligations can be minimised by timing the exit in line with periods of lower-earning, planned absences from the workforce or retirement dates, and all may influence the ownership split nominated now.
Ownership splits of 99/1 to secure the vast majority of claims in the highest income earners name are now frowned upon by ASIC. They mandate that a borrower must stand to gain a ‘distinct benefit’ from being a co-borrower and 1% no longer amounts to that in their view.
To have a 1% interest and liability still means that borrower is jointly responsible for the entire debt and they must seek independent legal counsel before committing to such an arrangement. The accountancy fees for a 1% benefit is also unlikely to be justified by the small tax benefit.
The minimum is now a preferred 80/20 split.
In the case where a couple decides to have the property 100% in the higher income earners name, if the equity offered to secure the purchase is jointly owned, the other partner will be required to be a guarantor, and therefore is jointly responsible for the loan.
What one owns, the other does too, and what one owes, the other does also!
Deciding on the ownership split is a decision best made in conjunction with your accountant and mortgage broker.
A couple buying together will nominate whether they want to be:
- Joint tenants
Joint tenants hold the property equally between them and the income or loss from the property will also be split evenly. The property can only be disposed of wholly, not in parts and on death, ownership of the property passes to the surviving owner. Most committed couples would elect to have this setup.
2. Tenants in common
Shares in the property can be uneven (in line with the lending and regulator’s guidelines), and so the income and tax benefits are attributed according to percentage ownership. Tenants in Common can dispose of their share if they choose to. On death, the will of the deceased determines the outcome of the deceased’s share in the property.
ATO – Co-owners of a rental property