Question Mark

CAPITAL GAINS TAX

I bought my first property six years ago for $250,000, a three-bedroom house in Brisbane. Initially I rented it out, because the tax breaks made it a lot cheaper, and rented a place of my own. After four years I got married and moved into the house. Now, with one child and another on the way, we need more room and have decided to sell. The agent reckons it is worth about $375,000. I know home owners don’t have to pay capital gains tax (CGT) when they sell, but because I’ve also held the property as an investment, I’m not sure what my liability is.

Owner occupiers are generally exempt from paying any CGT; any capital growth you’ve achieved since moving into the property is CGT-exempt. However, because you held it as an income-producing investment for four years, you will have to pay CGT on the capital growth it achieved during that period.

To determine how much CGT you’ll have to pay, you need to know what the property was worth when you moved in. A registered property valuer will be able to provide an accurate valuation.

For example, let’s say that your property was valued at $325,000 when you moved in: that means a capital gain of $75,000. Because you held the property for more than 12 months, you’re only liable to pay CGT on half the capital gain, or $32,500. The actual amount of CGT you’ll have to pay on this sum depends on your marginal (top) tax rate.

You should also speak with your accountant regarding your individual situation to see whether there are any other issues that may affect your tax position.

RAISING THE RENT

My two-bedroom investment unit was looking a bit tired '” worn carpets, peeling paint, torn lino, etc '” so when my last tenant moved out, I did some modest renovations to bring it up to scratch. The work cost me $15,000, which I borrowed against the property. The rent had been $280 a week, but I believe the improvements mean I can charge more. What is a reasonable increase in the current market?

In principle, you will need to increase the rent by enough to cover the additional interest you’ll have to pay on the money your borrowed to fund the renovations. For example, if you’re paying 7% on $15,000, this represents an additional $1,050 in interest payments each year. To recoup this money, you’d have to increase the rent by $20 a week.

However, the actual rent increase will depend on market tolerance. The fact you have renovated the property to a certain level and spent money doing so does not mean tenants will automatically be prepared to pay what you’re asking.

This is why it’s important to find out what similar properties (land size, number of bedrooms and bathrooms) in the local area are renting for. If the rental amounts are similar to your preferred amount, you shouldn’t have too many problems.

If they’re consistently lower, however, you may have to revise your expectations. Far better to accept $5–10 less per week and secure a reliable long-term tenant quickly than hold out for the higher amount and lose money hand over fist as the weeks tick by without a lease being signed.

THE DREADED D.E.F.

Two years ago I took out a $335,000 loan for my home, which I’ve been paying off as quickly as I can. At the time I had just begun a business so I had to get a low-doc loan at higher interest rates. Now my business is well established and I have the figures to prove my income, I want to refinance to a mainstream home loan on a cheaper interest rate. The lender has told me that I have to pay a deferred establishment fee of $2,228. How can I get around this?

For the benefit of our readers, a deferred establishment fee (DEF) is a penalty payable if you break out of a loan contract early. DEFs apply mainly to low-doc loans and other loans where the borrower is considered to have a higher than average risk of defaulting on loan repayments.

The fee payable differs between loan products and reduces over time. The exact amount is detailed in the loan contract. As a general guide, however, DEFs start at about 1.5% of the loan balance if you break out of the loan in the first year or two, dropping to about 0.5% after five years.

If you’re going to refinance to a different loan with the same lender, negotiate with them to waive the DEF. When faced with the alternatives of waiving the fee and keeping your business, or charging the fee and losing your business, it’s not hard to predict which option they’ll take!

If you’re refinancing to a different lender, there’s not much you can do to avoid paying the fee. However, if the new loan has a lower interest rate and/or a more competitive fee structure, you may well claw back the amount you paid to your previous lender.

Now that you’re aware of the DEF, avoid making the same mistake twice. Ensure that your new loan doesn’t include a provision to charge this fee, or you’ll be in the same position next time you refinance.

OFF-THE-MONEY

My husband and I live in Penrith, in Sydney’s west. We’re in our late 50s and we’ve owned our home since we married 35 years ago. We paid off the mortgage some time ago. About five years ago we bought an investment property off the plan at a cost of $450,000. The intention was to supplement our super, but when we asked an agent to appraise it, we found it was worth $50,000 less than what we paid for it!

We plan to retire in five years’ time. We’d like to sell the property then, and put the proceeds into our super. However, I know that the Sydney market has been flat for some time. What do you think we should do: hold the investment property until we retire and hope the market picks up during that time, or cut our losses and sell it now?

It’s fairly clear your investment property is underperforming. You’re not alone in this situation. Many off-the-plan purchases have shown little or no capital growth over the past few years. Some, like yours, have even gone backwards. This is because investors generally pay a large premium to get into the development when it was brand new. In your case, the property is now worth less than what you paid because buyers aren’t prepared to pay the same for a second-hand property as a new one.

Given that the overall Sydney market is yet to show any signs of recovery, your property’s underperformance is likely to continue for the next few years at least. Even if you hold your investment property until you retire, you’re unlikely to achieve much capital gain, whilst spending a considerable sum on interest repayments and other holding costs. This means you could go even further backwards.

By cutting your losses now and selling the property, you can put the sale proceeds into a higher-quality asset, stop the financial bleed and even begin to see some solid capital growth. Residential property is really a long-term proposition; investors should be prepared to hold it for at least seven to 10 years.