Tax with Max: Super standstill

Although the Coalition Government has won the federal election, by not having a majority in the Senate there is no guarantee of them passing the reforms to superannuation set out in the 2016 budget. It can be only hoped that, with one exception, all of the reforms are passed.

The reforms that do make sense from an equity point of view are the imposition of the $1.6 million limit on pension accounts, the removal of the 'work test' from making superannuation contributions for people 65 or older, and allowing all individuals to make tax deductible concessional super contributions. 

The policy that I hope will not be passed in its present form is the retrospective $500,000 lifetime limit placed on non-concessional contributions, which is backdated to non-concessional contributions made since July 1, 2007. If this is not amended this will be the first ever retrospective change to superannuation.

In answering questions recently about the proposed $500,000 limit I confused myself and some of our subscribers. If the budget proposal is passed as it is, anyone that exceeded the limit with contributions up until budget night will not have to withdraw the excess. Where a non-concessional contribution is made after budget night, the excess must be withdrawn.

For example, if a superannuation fund member had made $450,000 in non-concessional contributions up until budget night, contributed $180,000 on June 15, 2016, and the current retrospective nature of the policy remains, that member would have to withdraw $130,000. If they had contributed $630,000 before budget night, nothing would need to be withdrawn.

Q. I am 65 years of age, still working full time, and my wife is not working. We are about to demolish our home of 23 years, subdivide, and build two new double-storey homes on each block. Could you tell me if what I read on an ATO website is correct, in that if we live in one of the homes after completion for three months, sell it, then live in the other house, we are not liable for any CGT?

Answer: Unfortunately the income tax rules relating to capital gains are so complicated there are many differing interpretations issued by the ATO. In simple terms a person does not pay income tax when they make a profit on the sale of their main residence.

A person can only have one main residence. Based on what you found on the ATO website you can be forgiven for thinking that no tax would be payable on the gain as you would only have one main residence that you live in for three months, sell, then move into the other your new main residence.

I know of a number of tax rulings that provide a different ATO interpretation of what you are planning to do. In one you would be regarded as engaging in a profit-making undertaking or venture. If this occurred you would only get a capital gains tax exemption for one residence, but with the other the profit could be classed as business profit resulting in a loss of the 50 per cent capital gains tax exemption.

Of even greater concern if this interpretation could be applied by the ATO you would also need to register the project for GST, which would result in a percentage of the amount you received for the property sold having to be paid to the ATO.

If you did what you are planning to do, despite what you may have read on the ATO website, you could also find that the anti-avoidance provisions of part IVA of the tax act could be applied. This catch-all section of the income tax assessment act results in tax payable on any scheme where the sole or dominant purpose was to obtain a tax benefit.

The term scheme is not limited to only tax avoidance schemes dreamed up by clever tax lawyers and accountants. In a guide issued by the ATO to help people understand when IVA would be applied, it lists eight matters specified in the act that they use in assessment: 

The first five of those criteria that apply to individuals are:

1. The manner in which the scheme was entered into or carried out.

2. The form and substance of the scheme.

3. The time at which the scheme was entered into and the length of the period during which the scheme was carried out.

4. The result achieved by the scheme under the income tax law if part IVA did not apply.

5. Any change in the financial position of the relevant taxpayer has resulted, will result, or may reasonably be expected to result from the scheme.

Because of the potential harmful tax consequences of what you are planning to do if the ATO decided to attack it, you should seek professional advice from an accountant that specialises in capital gains tax.

Q. My wife and I are buying an investment property and plan on replacing the stove, oven and some cupboards in the kitchen. We also plan on replacing the entire bathroom. Some of the carpet needs replacing as well. Is any of this work tax deductible? As we plan to do this work before we place a tenant in the house does it affect us from claiming a tax deduction on the work?

Answer: As a general principle the costs of getting a rental property into a condition that it can be rented cannot be claimed as a tax deduction. This means the costs associated with the work being undertaken cannot be claimed as an immediate tax deduction, but a tax deduction can be claimed under the depreciation rules.

If any of the improvements cost $300 or less you can claim an immediate tax deduction for them. However if an item forms part of a set of items, such as one kitchen cupboard that forms part of an entire kitchen renovation, an immediate tax deduction cannot be claimed.

Any improvements that cost more than $300 but less than $1000 can be included in a low value asset pool and written off at an accelerated rate. In the first year these items are purchased a tax deduction of 18.75 per cent of the total value of the pool can be claimed, and in subsequent years a claim of 37.5 per cent of the written down value of the pool can be claimed.

The depreciation rules relating to rental properties for all other items not covered by the low value assets, or immediate write-off rules, are very complicated. For example, because the kitchen cupboards are fixed to the building the ATO regard these as a structural improvement that have a much lower depreciation rate. By contrast the carpet you are replacing can be written off over 10 years using the prime cost method, or at 15 per cent per year using the reducing balance method.

If you want to maximise your tax deductions for the rental property you should engage the services of a quantity surveyor to prepare a depreciation schedule. The cost of a depreciation schedule can vary between $550 to much higher. This cost is tax-deductible and in my experience the increased tax deduction for depreciation far outweighs the cost.