Bruce Brammall, 29 November 2017, Eureka Report
SUMMARY: Property investors have two new super tools available to cut their capital gains. Here’s how to plan to save CGT.
Property investors don’t get a lot of sympathy in general.
And, okay, it’s a bit understandable. In recent decades, property investors have made squillions, as property markets continue to deliver long-term real gains.
Occasionally, however, they get a win in a way that would appear to be unintentional.
The new five-year catch up rules for concessional contributions (CCs) are going to be one such way. Combined with the removal of the “10% rule” for making CCs, property investors have an extra couple of chisels in the tool kit to reduce the amount of capital gains tax they might pay on the disposal of an asset.
To get the best results from these two new rules will require some medium to long-term planning – up to five years out.
At its simplest, the new five-year catch up rules, which don’t come into force until 1 July, 2018, will allow you to make contributions for up to four previous financial years to the annual $25,000 limit, for any unused CCs.
This means that if you didn’t use up your entire $25,000 CC cap in those years, you can make catch-up contributions. For example, if you only made CCs of $10,000 in each of years FY19, FY20, FY21 and FY22, then in FY23, you would be able to make your $25,000 contribution for that year, plus possibly another $60,000 (four years times $15,000) to catch-up on the $25,000 limits that were not used during FY19-22.
In this example, it would allow you to make a CC in FY23 of $85,000, which would be attributed across those five years.
This would get $85,000 into your super fund, which would then be taxed at 15% instead of your marginal tax rate (of up to 47%). And, importantly, it reduces your taxable income by $85,000, potentially taking you into a much lower marginal tax rate.
If you hadn’t made any contributions in the four previous years, you would be able to make a deduction of $125,000 in the fifth year.
Important notes: The ability to use the five-year catch-up provisions is limited to those with less than $500,000 in super. If you have more than $500,000 in super, you will be limited to using your annual cap of $25,000. And, of course, you will still need to meet the work test in order to make the contributions. Employees receiving 9.5% from their employer should understand that Superannuation Guarantee Contributions (SGC) count towards your CC cap.
Further, the removal of the “10% rule” means that anyone eligible to make contributions can make tax-deductible CCs to their super fund, at any stage during the financial year.
Combining these two rules will be of great benefit to many property investors at the time of sale. And there will be some extra benefits for the self-employed, who have more choice over when contributions will be made.
How will this reduce my tax?
Take a couple who jointly owned a property for 10 years, on which a gain of $300,000 was made. That gain becomes $150,000 each. This is then reduced by the 50% capital gains tax reduction for assets held for longer than a year.
So each member of the couple has an additional $75,000 to add to their other income, on which they must pay tax.
This will result in tax of up to 47% being paid on that $75,000, depending on what other income has been earned.
However, if it was sold in the 2022-23 financial year, they could potentially make a tax deductible contribution to their super fund of $75,000 to reduce their taxable income – potentially, in this case, to effectively wipe out the entire gain.
Selling before FY23
For those who sell a property in the first few years after the catch-up provisions start, your ability to use the new rules will obviously be a little limited.
The five-year catch up rules start on 1 July, 2018 and will not be retrospective. That means that you won’t fully be able to use all five years until the 2022-23 financial year.
So, if you were to sell your property in FY21, you would only have the $25,000 CC cap from that year, plus any unused portions of your CC caps from FY19 and FY20.
For those who know they are likely to sell in a few years – such as those approaching retirement or those knowing they will need to fund something big such as a renovation or school fees – the opportunity to manage your tax and the CGT you pay on the sale of your property could become considerable, though complicated.
At it’s simplest, if you know that you are going to sell a property after FY23 with a big capital gain, you could potentially pay yourself no super for five years, allowing you to make a contribution in that fifth year of up to $125,000.
This is where the self-employed will have an even bigger advantage, as they have the choice to pay, or not pay, themselves CCs in a given year.
(This might not make sense if you are in a high marginal tax bracket and are not completely sure you will need to sell and might be best making ongoing contributions.)
For employees, you will need to take into account how much SGC has been paid by your employer (or employers) into your super fund during previous financial years.
But if you take someone earning a salary of $100,000, who has made a gain of $100,000 (after the 50% discount) after FY23 has some serious planning opportunities to help reduce that tax via super contributions.
Particularly if they knew this would occur a few years out.
They might decide to stop making extra salary sacrifice or other deductible contributions for a few years before the sale.
This might result in slightly higher tax being paid in early years, with the benefit being achieved in the year of sale.
For example, someone earning $120,000 might be topping up the $11,400 in SGC being made by their employer, by salary sacrificing an extra $13,600 into super. This would reduce their taxable income to $106,400. But would still leave them in the 39% marginal tax bracket.
If they knew that a property sale was coming up that would take them significantly over $180,000 and into the top tax bracket, they might decide in earlier years to not make those extra salary sacrifice contributions, to save them up for when the big CGT occurs.
Not everyone can benefit
But they won’t benefit everyone, obviously. For those on high salaries, who are already at, or near, the $25,000 annual CC limit, there will be no, or limited, benefit.
Equally applicable to shares
The above is equally applicable to capital gains made on shares. However, I’ve concentrated on property, as shares can be sold in parcels over a number of years and therefore have an added dimension to being able to manage tax payable.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.
Bruce Brammall is managing director of Bruce Brammall Financial and is both a licensed financial adviser and mortgage broker. E: firstname.lastname@example.org . Bruce’s book, Mortgages Made Easy, is available now.