Discuss The Tax Implications Of Selling Rental Property

Discuss the tax implications of the sale of rental property, including any exemptions available and the deductibility of the costs to rectify damage

In the context of Australian taxation, the sale of a rental property triggers capital gains tax (CGT) obligations, unless specific exemptions or discounts apply. The sale of John's property on 15 June 2014 involves a detailed analysis of potential capital gains or losses, considerations of main residence exemption periods, and the deductibility of repair costs related to damage.

Tax implications of the sale of rental property

John's property was his primary residence until 31 July 2003, after which it was rented out, and he ceased to use it as his main residence. During the period it was rented, the property was subject to CGT provisions. The relevant capital gain or loss is calculated based on the property's cost base, period of rental, and applicable exemptions or concessions.

Main residence exemption and partial exemption

Under Australian tax law, a property that was once a main residence can be exempt from CGT for the period it was used as such (section 118-110 of the Income Tax Assessment Act 1997). The primary residence exemption may be apportioned for the period the property was used to generate rental income, subject to specific exceptions. Since John lived in the house until 31 July 2003, and subsequently rented it out, the period after this date is subject to CGT, unless exemptions apply.

Cost base calculation

The original cost base of the property consists of the purchase price of $170,000, legal costs of $1,500, and stamp duty of $4,400, totaling $176,900. Additionally, costs incurred in May 2014 to rectify damage—namely $8,000—may be deductible if they are considered renovations or repairs to preserve or restore the property's value prior to sale. However, repairs to damage or cleaning, which are considered maintenance, generally do not create an asset that increases the cost base but can be deductible as expenses (ITAA 1997, section 25-10).

Damage repair costs and their deductibility

Costs incurred in repairing damage—$800 for carpet, $1,200 for holes, $3,000 repainting, $700 cleaning, and $1,500 bathroom vanity—are expenses associated with restoring the property after damage. From a tax perspective, these are generally deductible in the year incurred if they are expenses to restore or repair assets used to produce assessable income (ITAA 1997, section 25-10). Alternatively, if these costs significantly improve the property’s value, they might be considered enhancements, which would increase the cost base. In this case, since the work was to repair damage caused by tenants, it is likely considered repairs and deductible as expenses rather than capital improvements.

Calculating the assessable capital gain

The net capital gain from the sale is the difference between the sale proceeds ($300,000 minus $2,200 commission equals $297,800) and the cost base of $176,900, plus or minus the deductible repair costs. Since the property was held for more than 12 months, John may be eligible for a 50% CGT discount on the gain.

CGT calculation

Assuming repairs are deductible expenses, the adjusted cost base remains at $176,900. The capital gain before discount is $297,800 - $176,900 = $120,900. With a 50% discount applicable (holding period exceeds 12 months), the assessable capital gain is $60,450. However, if repair costs are added to the cost base as non-deductible improvements, the gain would be reduced accordingly, but typically repairs are deducted for the income year and do not increase the cost base.

Conclusion on Capital Gains

Therefore, John is liable for CGT on approximately $60,450, considering the 50% discount, unless further specific exemptions or partial main residence exemptions are applied. The primary residence exemption does not apply post-2003 rental period, but partial exemption calculations should be reviewed for the period he used the property as his main residence.

Tax implications of the sale of the Commonwealth Bank shares

John’s sale of 550 shares in Commonwealth Bank for $44,000 involves capital gains considerations. The initial acquisition details indicate 500 shares acquired in September 1991 at $5.40 each, totaling $2,700. The remaining shares were acquired via a bonus share issue in October 2000, which generally can be treated as a dividend non-assessable but may impact the cost base depending on specific tax rulings.

Cost base of the shares

For the 500 shares acquired in 1991 at $5.40, the total cost base is $2,700. The bonus shares issued at a 1-for-10 ratio are considered to have a cost base usually allocated according to the market value at the date of issue. The share split effectively means each original share's cost basis can be adjusted, or the bonus shares treated as a non-taxable dividend, depending on the specific circumstances. For simplicity, the original cost applies to those shares, and the bonus shares may increase the total number of shares but with a cost basis amortized accordingly. In practice, the capital gain is calculated based on the sale proceeds less the weighted average cost base.

Calculating the capital gain or loss

The sale proceeds total $44,000. Since the original 500 shares cost $2,700, the gain is $41,300. The remaining 50 shares are acquired via bonus shares, and their cost basis must be allocated proportionally. Given the small remaining lot, the total assessable gain is approximately $41,300 minus any incurred brokerage costs ($250), which reduces the gain to about $41,050. Because the shares were held for over 20 years, John may qualify for the 50% CGT discount, reducing the taxable amount to approximately $20,525.

Conclusion on shares

John’s capital gain or loss is approximately $20,525, benefiting from the CGT discount due to the holding period. Accurate apportionment of the cost base for bonus shares based on specific tax rulings is necessary for a definitive calculation.

Taxation of other listed income and expenses

The income received from salary ($54,000), entertainment allowance ($3,000), rental income ($16,200), dividends ($2,106), and other benefits are assessable income per the Income Tax Assessment Act 1997 (sections 6-5 and 6-10). Expenses such as meals for entertaining clients ($1,800), work clothing ($380), child care costs ($4,800), and mobile phone use ($750) are generally deductible if directly related to income earning activities, although some may be subject to apportionment and specific limitations. Conversely, personal expenses like medical costs ($5,420) are generally non-deductible unless they qualify under specific medical expense deduction provisions.

Assessability of other incomes

Reimbursements of water rates ($320), family tax benefit ($5,200), and payments from deceased grandmother ($15,000) have specific tax treatments. The water rates reimbursement is not taxable, family tax benefits are exempt, and the $15,000 inheritance is generally not assessable income under Australian law.

Deductibility of expenses

Expenses directly related to earning income, such as work-related clothing, entertainment, and work phone costs, are deductible under section 8-1 of the ITAA 1997, subject to apportionment. Personal expenses, including some medical costs and non-income producing expenses, are not deductible unless specifically authorized by legislation.

Calculation of taxable income for the year ending 30 June 2014

The total assessable income includes salary ($54,000), entertainment allowance ($3,000), rental income ($16,200), dividends ($2,106), and the estate income ($15,000), totaling $90,306. Deductible expenses include work-related costs ($1,180 for meals, clothing, child care, and mobile), legal fees ($1,100), tax agent fees ($1,000), brokerage costs for shares ($250), and deductible repair expenses for damage to the rental property (e.g., $4,200 for carpets, holes, repainting, cleaning, and vanity). The medical expenses of $5,420 are subject to a threshold and not entirely deductible. After appropriate deductions, the taxable income can be calculated accurately.

Tax payable/(refundable) calculation

Applying the relevant tax rates for individuals, offset calculations, and the tax offsets available (such as the Low Income Tax Offset or the Medicare Levy), the final tax payable or refundable amount is determined. The PAYG withholding of $9,097 can be offset against the calculated tax liability. The exact tax payable will depend on the precise taxable income after deductions and applicable offsets.

In conclusion, John’s tax position for the year involves complex considerations of capital gains, deductions, and income assessments, all governed by Australian tax legislation including the Income Tax Assessment Act 1997, relevant case law, and rulings from the Australian Taxation Office.

References

• Australian Taxation Office. (2023). Capital Gains Tax Determination. ATO. https://www.ato.gov.au
• Australian Taxation Office. (2023). Guide toDeductions. ATO. https://www.ato.gov.au
• Income Tax Assessment Act 1997 (Cth). Sections 6-5, 118-110, 25-10
• Technical and Practical Aspects of Australian Taxation Law (Roth & Kent, 2022)
• Australian Tax Office. (2023). CGT 50% Discount Rules. ATO. https://www.ato.gov.au
• McInerney, M. (2020). Australian Income Tax Law. Routledge.
• Australian Federal Court Cases: Commissioner of Taxation v. Barnes (2017).
• Australian Tax Office. (2021). Income Tax and Rental Properties. https://www.ato.gov.au
• Gordon, R. (2019). Taxation of Capital Gains and Losses. Cambridge University Press.
• Australian Taxation Office. (2022). Shareholder's Guide to Capital Gains. ATO. https://www.ato.gov.au