If your side hustle is property, then the CGT discount is not always guaranteed and here’s why

If property investment is more than a side hustle then the capital gains tax discount is not always guaranteed. Here’s what you need to know if you go pro.

If buying and selling investment properties has the hallmarks of a business then the CGT discount won’t be coming your way.

A common strategy for property investors is to accumulate multiple properties and get to a point where they can reduce or stop working because they have built up enough passive income from their investment property portfolio to supplement their employment income. However, being a successful property investor can actually lead to a potentially bad tax situation.

Under certain conditions the Australian Taxation Office is within its rights to disallow you from claiming the 50 per cent capital gains tax discount on selling properties that you have owned for more than 12 months.

The rules relating to the CGT discount are clear. If you own a property for more than 12 months you can ignore half of the gains that you have made when you sell the property.

In other words, someone on the highest marginal tax rate will pay a maximum of around 23.5 per cent CGT versus someone who sells an investment property within 12 months who will pay 47 per cent tax on the gain made.

But the problem could arise when the ATO decides that you are “carrying on a business of letting rental properties”.

In its eyes, no longer are you an individual who has been successful in property investment as part of your personal wealth accumulation strategy, You are now deemed as a professional property investor and your buy and sell activities are dealt with within business taxation rules, which means that the CGT discount is no longer available.

The ATO advises that the factors it used in “tax ruling 97/11” to assess whether someone is running a primary production business can also be used to assess whether someone is deemed to be running a property business, or whether they are just an individual investor.

The ATO looked at these eight factors when making the determination:

● Whether the activity has a significant commercial purpose or character;

● If the property owner has more than just an intention to engage in business;

● Whether the owner has a purpose of profit as well as a prospect of profit from the activity;

● If there is repetition and regularity of the activity;

● How and if the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business (real estate management);

● Whether the activity is planned, organised and carried on in a businesslike manner;

● The size, scale and permanency of the activity;

● If the activity is better described as a hobby, form of recreation or sporting activity.

Assessing these factors, there are several points which can be used against the average property investor and cause them to be deemed as a property business and lose the 50 per cent CGT discount.

In particular, this is the case if your property buy-and-sell transactions are somewhat frequent with the intent to make a profit and done in a way with businesslike organisation and planning.

As such, the message is clear – property flippers beware. Keeping in mind the move by the ATO to confirm a recent court win for a property investor was a “one off” event. The frequent buy-and-sell activity on property assets is one of the factors the ATO uses in deciding whether you are in the business of making profits from buying and selling property, which can mean you lose the 50 per cent CGT discount.

Similarly, people who have accumulated a large portfolio of property assets may be deemed by the ATO as being in the business of renting out investment properties and, again, no CGT discount applies.

And in a cruel twist, people who are exceptionally frugal and self manage their investment properties are more likely to be targeted and lose the CGT discount.

Losing the 50 per cent CGT discount is a big deal for most people. It is difficult enough to swallow the fact that just under a quarter of the gains made on investment properties purchased personally is lost in CGT.

But it is not all doom and gloom. There is a silver lining, especially for buy-and-hold passive income property investors.

Although as we have established, business property owners cannot claim the 50 per cent CGT discount, they do have access to things that the ordinary property investor cannot claim as tax deduction.

Expenses that are not normally able to be claimed in your individual tax return such as travel expenses, property research costs, real estate conferences and other personal costs such as internet and mobile phone, can potentially be claimed by people deemed by the ATO to be running a property business.

Another positive is that someone running a property business may be able to claim a yearly depreciation expense on the fixture and fittings from established property assets, which is something that normal property investors cannot do since 2017. Only depreciation on the fixtures and fittings of brand new properties can be claimed for property investors, but business property owners are exempt from these rules.

If you are deemed as a business property owner, small business tax concessions may be accessible when you sell, but it becomes quite complex and beyond the average mum-and-dad property investor at that stage to work out their tax position.

If the ATO comes knocking and says that it is going to treat your property assets under the business rules, immediately seek expert accounting advice so that you can make lemonade from lemons by trying to claim a higher level of annual property tax deductions to supplement the loss of the 50 per cent CGT discount.

James Gerrard is principal and director of Sydney planning firm financialadvisor.com.au