Ask Max: Your questions answered

Capital gains on subdivisions, switching to a wrap fund, cash in frozen funds, when a sole trustee dies, and ETFs.

Summary: This article provides answers on the capital gains payable on property subdivisions, on switching to a BT wrap fund, cash in frozen funds, what happens when a sole SMSF trustee dies, and the difference between exchange-traded funds and managed funds.

Key take-out: Some fund managers are now offering redemption windows for investors in frozen managed funds to redeem a certain percentage of their cash.

Key beneficiaries: SMSF trustees. Category: Portfolio management.

How can capital gains tax be minimised on a property subdivision?

I recently purchased an investment property and have the potential to subdivide it given it is 1,100 square metres with the house set down the back. I stand to make in the order of $200,000 if I subdivide and build a second home and sell both.

What are the CGT implications as the original house will now be on a smaller block and will decrease in value by say $50,000. The second block now on its own title didn’t actually exist prior and I have sold it for a clear profit. How can I minimise CGT?

To calculate how much capital gains tax will be payable on this subdivided property you must start with the original purchase price. You will need to work out what the underlying land cost was and what the value of the existing residence was. This can be done by getting a market valuation from a real estate agent or engaging the services of a registered valuer.

Once you know the cost of the land, the subdivision costs can be added to this amount, and the total land cost can be apportioned between the two blocks. The capital gain made on the house and the back block will be the difference between the net selling value and the combined cost for that block and the value of the original house.

For the front block you will add the construction costs of the new house to the costs of the land for this subdivided block, and the capital gain will be the difference between the net selling value and the total cost for the house and land. As the value of this house and land package will be more than $75,000, and you are undertaking a profit-making venture, you will need to register for GST.

Due to the complexities of what you are proposing, and the level of difficulty that is added due to the need to register for GST, you should seek advice from an accountant that specialises in capital gains tax and GST.

What are the advantages of switching to a BT wrap fund?

Our financial adviser suggests that we change our SMSF into a BT wrap fund. What are the pros and cons of this move? We feel our fund is doing alright. We are both in pension phase and only drawing $18,000 a year. Our fund is currently about $420,000

I would ask your adviser why and how you will be better off by following their advice. By law they should be able to demonstrate what the benefits and disadvantages are of you following the advice.

The only benefit could be possibly lower administration fees than the current cost of your SMSF. There are some major disadvantages that could outweigh this cost saving due to you being limited to the investments available on the BT wrap.

I would also be asking the advisor what if any commissions that they will be making as a result of rolling over into the BT wrap fund. You should proceed with a great deal of caution, and seek advice from the accountant who looks after your SMSF, as there are potential capital gains tax problems in rolling out of your SMSF into the BT wrap fund.

Are there many investors who still have cash in frozen managed funds?

During the financial crisis many managed funds and listed trusts within our Macquarie wrap super were frozen. They are still frozen and unable to be cashed. Our financial manager is aware that we would like to access this cash, but we have no power to. I would never have managed funds again because we cannot access our cash. I would like to know how many other people are in the same position?

You are definitely not alone when it comes to having frozen funds. What would be unusual is if these frozen funds made up the majority of your investments. If this is the case you may have grounds for registering a complaint against the financial advisor that put you into these funds.

Understanding why these funds were frozen, and how the better fund managers are dealing with the situation, could be of assistance to you. There are two main causes of why many of these funds were frozen. The first was the guarantee given by the Rudd government for funds held in bank accounts, and the second was the impact of the GFC on the amounts being invested in managed funds.

Before the GFC hit, when the cash flow into managed funds was considerable, fund managers were able to use new investors’ money to provide liquidity to pay out existing investors.

The combination of new investor inflows ceasing, and a move by many investors to switch from managed funds into the now government guaranteed bank deposits, meant if the managers had not frozen the funds the underlying assets would have been sold into a declining market. This would have resulted in investors suffering major realised losses.

Some fund managers are now offering redemption windows for investors to redeem a certain percentage or amount of the managed fund. There are other managers that have decided to wind up the funds and are selling the underlying investments in an orderly manner to reduce the likelihood of investment losses being realised.

You should contact your adviser to make sure that you have been made aware of any redemption opportunities offered by your fund managers so that you can start to sell down these investments.

What happens when a SMSF sole trustee dies or is unable to manage their affairs?

What happens when the sole shareholder director of an SMSF trustee company dies or becomes incompetent to handle his affairs?

In simple terms the personal legal representative of the shareholder/director takes over the duties of the person who has either died or become incapacitated. In this situation the SMSF would more than likely be wound up. In the case of the member dying this would result in the funds being distributed to their estate or in accordance with a binding death benefit nomination.

Where someone has become incapacitated the personal legal representative could pay out the member’s benefits if they have met a condition of release, and if they have not the superannuation would be rolled over into either a commercial or industry fund.

What is the difference between an ETF and a managed fund?

Are exchange-traded funds the same as traditional managed funds in their structure and management? If not, how are they different?

At their heart exchange-traded funds are the same as managed funds. In fact, in many cases an ETF is the same fund, with the same underlying share investments, that can be purchased from the fund manager as a regular managed fund. The big difference being that ETFs can be bought and sold on the sharemarket, thus providing greater liquidity than is available through a managed fund.

Another difference with an ETF is the way the market price is decided. There is in fact two markets that help regulate and keep the value of an ETF as close as possible to the net market value of the underlying shares. The creators and manager of the fund enter into contracts with broking houses that set the price by selling or buying large quantities of the ETF.

One of the big advantages of ETFs, apart from their liquidity, is the ease with which they can be bought and sold. Traditional managed funds often require a great deal of paperwork to buy and sell them, but with an ETF the buying and selling is as simple as buying and selling listed shares.

Before purchasing an ETF you should seek advice from an investment professional that can go into greater detail and assess whether you would get a benefit from investing in them.

Max Newnham is a partner with TaxBiz Australia, a chartered accounting firm specialising in small businesses and SMSFs.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

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