property taxation

Prof. Dominique Fischer, Curtin University

Property taxation

The treatment of income producing properties in

Western Australia

This presentation is illustrated by a companion Excel worksheeet

Updating: May 2003


Bon appétit!

ATO tax menu

On operation- allowable deductions

- financing expenses

- capital allowance

- depreciation

-On disposition- recapture

- capital gain

- GST

State tax menu

1. Stamp duties

2. Land tax

3. Emergency Service Levy

4. Metropolitan region improvement tax

Local tax menu

1. Local Rates

2. Water rates

3. Parking fees

You can always return to this menu by clicking on the Pink house (in slide show

mode)


Taxed by whom? when? On what?• Income producing properties are taxed at three levels:

– Federal– State– Local Governments

• Taxes can be levied:– Annually: income tax, GST, land tax, local rates, etc.– On transaction: stamp duties, capital gain

• And applied to:– Value: land tax, rates, stamp duties, capital gain– Activity level: income tax, GST– Gross rental value: council rates, water rates, emergency services


Federal level: the ATO tax menu

• The ATO will tax income producing properties at different stages: – operation

– acquisition/disposition

– and good and service indirect leviesSee notes for the various

types of taxpaying entities


The State government bite…

• Stamp duties charged to the purchaser

• A land tax is charged annually on land values

• Emergency service levy: the new baby…

• Metropolitan region improvement tax

• Back to the menu of federal taxation


Some indicative numbers (millions of $)

Taxes on property Land tax 266.50 $

Stamp duties 799.00 $

Total 1 065.50 $

As a percentage of State total annual taxation 34%

As a percentage of State total annual revenues 9%


The local government levies

• Property rates calculated on the gross rental value of the property

• Water rates

• Parking licence taxes (applicable in Perth)


Menu of state and local taxation

1. Stamp duties

2. Land tax

3. ESL tax

4. Metropolitan Region Improvement tax

5. Council rates and water rates

6. Parking levies


Stamp duties : duties on what?

• Tax imposed on various types of documents used in a property transaction:

– Transfers of real estate;– Mortgages;– Leases.

• Stamp duties are not limited to property transactions and can be charged on:

– marketable securities (not applicable after July 2001);– documented gifts;– policies of insurance;– issue of motor vehicle licences;– business of renting goods (except books).


Rates and concessions

• The rates are progressive and based on transaction values• Two stamp duties may apply: one on the property transaction

and the other one on the mortgage transaction (including on refinancing….)

• Check your Excel workbook for rates and examples

• Concession rates apply to home owners principal residence (value capped)• Rebate of 500 $ may apply to first home buyers (value capped)• Transfer of farm properties between family members are exempted• Corporate reconstructions are exempted

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Since January 2004:no duties on unsecured loansMortage dut rate is a straight 0.4%


Duties on leases

• The lease document is `stamped’, thus a duty applies;

• Duty based on total rental contract amount;

• The dutiable rental is GST inclusive.– Stamp duties on lease were supposed to be eliminated in

2003…

– And were eliminated in March 2004….

– But still duties on a lease of land in consideration for a premium.


Complications

• Since the ‘stamp’ is charged on the document, the nature of the transaction may affect the duties:– No duties on shares of listed properties;

– Different treatment of private unit trusts;

– Possible duties on shares of ‘land rich companies’;• Cies that own land valued over 1M in WA

• Cies that have 60% of their assets as land (under review)

– Duties are applicable to option fees. Then on property value at exercise time.

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Was previously 80% and dropped to 60% in January 2004.

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The treatment of options has been modified in January 2004.


The future…

• The whole package of State taxes is presently under review.

• A 2002 reports suggests the abolition of quite a few stamp duties… however not on property transactions.– Streamlining Western Australia's Tax System - Fewer,

Fairer and Simple, The final Report of the Review was presented to Government on 28 February 2002.

The report can be found on http://www.treasury.wa.gov.au


Land tax

•Based on assessed unimproved land value

•Levied by the department of treasury

•Assessed by DOLA (the valuer general)


Duties on what?

• Annual tax on assessed land value

• Paid by the owner (usually passed through to tenants)

• And the lessee of Crown land


How much?

• Rates have been amended in 2001 (Land tax bill 2001)

• Starting July 2002: land tax on properties with an unimproved land value of less than 50 000 has been abolished

• High value properties are now taxed at an increased rate

• Check the Excel workbook for rates and examples


Exemptions

• Principal residence exemption is limited to direct owner-occupation

• Not to Trusts, nor to Companies

• Except if:– Trust in favour of a disabled beneficiaries

– At least one of the disabled used the land for primary residence


Emergency service levy

• Starts in July 2003

• Levied in order to fund WA fire and emergency services

• Replaces existing arrangements used in the financing of fire and rescue services, Bush fire brigades and the State emergency service (SES)

• And should replace various insurance schemes

• Check the Excel workbook for rates and examples


Duties on what?

• Annual tax imposed on the gross rental value of the property

• Applicable to all properties including vacant blocks regardless of ownership


Complications

• From 1 July 2002, removal of the principal place of residence exemption for properties held by companies and trusts.

• Objections to land valuation are dealt by DOLA


Metropolitan region improvement tax

• 0.15% of unimproved value of land for properties that are subjected to a land tax

• In my humble opinion…– Who is the #$%%@@ that has created this anachronism?

– If land values are related to ‘metropolitan location’ then the land tax already captures the ‘metropolitan’ advantage and we don’t need this tax heresy.

– Back to the menu of State and local taxes


Council rates and water rates

• Rates are levied by local councils

• Property rates are decided by the local governments

• Each local government may have different asset categories

• Water rates are getting closer to user’s fees for water and sewage services.


Duties on what?

• Annual tax imposed on the Gross rental value of the property (check this slide’s note)

• Amended rate accounts can be issued where the Valuer General considers the Gross Rental Value of their property has changed.


How much?

• It depends… a list of all taxing WA local authorities can be found at:– http://www.walga.asn.au/locgovinfo/councilwebdir.htm

• Where the property is vacant land, an equivalent GRV, based on 5% of the property value, is used.

• For a given rate of say 8% the rate is calculated as.

• GRV x Rate in the dollar (0.08 $) = Amount of tax to pay


Parking levies

Applicable to Perth only (for the time being…)


Duties on what?

• Annual tax on property owners in the Perth Parking Management Area

– Exemption if less than 5 bays

– Exemption for loading bays

– If you really want to know…. //www.dpi.wa.gov.au/planning/parking/policy.html

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was 6 before...


How much?

• Business with more than 5 parking bays:

– Motorcyles bays: 77.50 $/ year

– Short term public bay: 155 $/year

– Long term public bay and tenant parking: 180 $/year

– Bicycles and roller skates are still free… just wait!.


The taxation of rental income

• The full amount earned on a rental property is declared

• Various deductions will lead the amount of taxable income to add to your other sources of income and taxed at your marginal rate

• Tax liability must be paid quarterly under a PAYG principle if rental income > 8000 $– Rental income generated on properties held outside

Australia are also taxable… With different deductibility conditions.


Rental income

• Effective gross income

• + Any other sources of rental related income

– Could be payments in nature

– Could be retained bond money left by tenants

– Or an insurance payout

– Or the reimbursement of expenditures by a tenant


What can be deducted

• Operation expenditures

• Leasing incentives

• Financing expenditures

• Depreciation


Deductible expenses from operation

• Normal and periodic expenditures that are related to the operation of the property…

– Council rates, water rates, ESL levy, Land tax….

– Insurance

– Servicing contracts

– Pest control

– Management fees

– Etc.


Operating expenses deductions

• Matching principle:

– Deductions are related to income produced: no income… no deduction

– No `reasonable expectation of income’… no deduction

– There must be a causal link between the deduction and the source of income (ex: travelling expenses related to rental property)


Leasing incentives

• Lease incentives payed by the lessor are deductible in the year

• Period free rental is not accepted as a deduction and are not assessable in the hands of the lessee

• Concessionary lending rates are not accepted as a deduction and are not assessable in the hands of the lessee

– A better source: tax ruling IT 2361


Apportionment of deductible expenses

• Pro-rata allocation of income and expenses if:– Property not held for a full year: pro-rated for time

– Property held by different owners: pro-rated for share

– Property is partially used to generate rental income: pro-rated for floor space

• Pro-rating means: applying a percentage of the number of days of ownership. Example for a property owned for 60 days, the amount deductible would be 60/365 of the expense. If a taxpayer owns a third of a property, she will be able to deduct only a 1/3 of the expenses. Etc.


Operation or capital

• Picking the fruits: operation expenditures– Operating expenditures are related to ongoing activities

and are deductible during the year of operation

• Planting a fruit tree: capital expenditures– Capital expenditures are linked to the acquisition, the

betterment or the disposition of a property

– Capital expenditures are amortised or applied to reduce capital gains.


Repairs and maintenance

• Can be treated as operation or capital expenditures.

• Depending on the nature, importance and frequency of the expenditure.– If the repairs increase value: capital expenditures

– If the repair expenditure is a substantial part of the value… will be treated as capital expenditure

– If repairs required at acquisition (initial repairs)… capital expenditure


Fit outs (tenants improvements)

• If the lessor (the owner) pays and owns the fit out: non deductible in the year (capital expenditure);

• If the lessee pays part of a fit out that he may remove at the lease… the lessor may deduct his contribution to the cost


Depreciation of buildings (building allowance)

• Technically defined as a special building write off deduction

• Capital allowance on capital work = Buildings + items that are incorporated in a building

• But not on land…

• The undepreciated value passes to the new owner but depreciation is not based on purchase price.

• An estimate for a qualified professional can be used if construction cost is unknown

• Building allowance is not recaptured at disposition but will affect the cost base.

See notes


Capital work… means:

• Construction expenditures for a building or for extensions

• Other incorporated constructions: garage, pergola, carport

• Retaining walls, concrete driveway, swimming pool, fencing

• Built-in cabinets, electrical wiring, doors and windows fitting


Construction costs include

• All hard construction costs (labor, material and profits)

• All soft costs required before or during construction (architect fees, legal fees, valuers, property research)

But cannot include:

– Land value

– Land clearing and plotting

– Landscaping expenditures


Applicable rates… it depends!

• Construction started before 1985: 0%

• Construction started before 1987: 4%

• Construction started after 1987: 2.5%– The allowable depreciation (capital cost allowance) is

pro-rated to the length of possession and or length of rental


Plant (now defined as ‘depreciable assets’)

• Plant: anything that is a non integrated part of a property: fixture, machinery, furniture, carpets, curtains, etc..

• Can be removed from the building without damage

• Allocation between plants and other assets must be based on reasonable estimates but do not need to be part of the purchase contract.

• If a fixture is built-in: it will be depreciated as a building


Decline in value of depreciable assets

– Diminishing value method (declining balance)

– Straight line method (prime cost)

– Pooling for low cost (<1000 $) assets at a 37.5% rate (1/2 rate for the first year)

• Check the Excel workbook for examples

• Information on rates: TR 2000/18

– Depreciation can be recaptured at disposition


Operation losses

• Can be carried forward

• Not backward…

• This carry over is subjected to ‘continuity of ownership test’ (COT) or ‘same business test (SBT) constraints– COT: the owner still owns at least 50% of the ‘loosing’ cie.

– SBT: a set of criteria evaluate the continuity and similarity of activities (TR 1999/99)

• Specific rules apply to Property Trusts


Acquisition/Disposition: various forms

• Sale

• Exchange

• Gift

• Foreclosure

• Demolition and destruction

• Ceasing residence in Oz


Taxation at acquisition

• Review of some points raised previously:– Stamps duties and other acquisition costs are included in the

transaction cost

– Depreciation starts at the level left by the previous owner (the seller must provide a notice of building allowance within 6 months)

– Financing related expenditures can be spread over the lesser of the term or 5 years

– Initial repairs are treated as a capital expenditure

– The acquisition cost should be allocated between components (buildings, land, plants and other assets)


Taxation at disposition

• Capital gain taxation

• Recapture of depreciation

• And GST consequences….


Capital gain

• Put in place in 1985

• Triggered by a CGT event on sales of:• Collectables

• Personal use assets

• Other assets (including property assets)

• Dwelling units are generally exempted

• CG are added to your income and taxed at the marginal rate

• CG = Capital proceeds – Reduced cost base

See notes on dwelling treatment

See notes on

CGT events


CG : what’s in between the 2 yellow dots…

Disposition price

Net disposition price

Capital expenditures

Written down value

Acquisition price

Check the Excel workbook for calculations and the note below for an exampleSee

notes


How to tax capital gains

• 3 methods (see note)

– With indexation

– With the discount method

– With the ‘other method’

• Indexation adjust the cost base for inflation

• The discount method applies a discount of 50% to CG

• The ‘other method’ applies to assets held for less than 12 months. The CG is not discounted.


Recapture = called `Balancing adjustment’

• When net disposal is greater than the depreciated value of the plant.

• Building depreciation is not recaptured but it increases the capital gain (by reducing the cost base)– Thus, with the discount method applied to compute capital

gains, a 50% recapture occurs.

Disposal of depreciable assets: definitions

Termination value

Adjustable value

Net acquisition cost

Sale proceeds minus sale

expenses minus GST

Cost of the plant less allowable

depreciation

Decline in value


Evolving ATO jargon

• Depreciation = decline in value

• Undeducted cost = adjustable value

• Written down value = adjustable value

• Plant = depreciable assets

• Owned = Held


Partial recapture

Termination value: 90,000 $

Adjustable value80,000 $

Net acquisition cost 100,000 $

10,000 $Are recaptured or can be offset against a new acquisition


Full recapture


Adjustable value80,000 $


20,000 are fully recaptured or offset


Final balancing adjustment…


Adjustable value 80,000 $


30,000 $Are still deductible


And GST consequences…

• Check the Excel workbook and specific powerpoint presentation for GST details and examples

property taxation

Documents

local rates

income tax

purchasera land tax

lease of land

examplesconcession rates

concessionsthe rates

property value

gstgross rental value