Reader question: I am trying to figure out what to do regarding a current investment property, This is my scenario:

I and my wife currently live in a rental property for which we pay $325 per week. I have owned another property I bought in June 2009 @ $413,000 I suspect it could be sold now for approximately $575,000. I would like to look at moving back into my $413k property but if I am never going to get a massive reduction of CGT then there is no advantage. I am also looking at maybe leaving the $413k property as it pays $460 per week rent and buy another place of primary residence. Have you got any suggestions?

My dad always told me to never worry about Capital Gains Tax (CGT) if you never plan on selling your investments.  Great advice but not entirely correct as careful tax planning now could save plenty of headaches (and tax) down the track.  Your situation is interesting and I would thoroughly recommend you sit down with an accountant or financial planner to work out a few possible alternatives.  I will outline a few issues to consider.

If you originally lived in your investment property when you first bought it back in June 2009 then this would provide the ideal outcome for you.  Should that be the case then you could trigger the principal place of residence exemption and elect to have the property free of CGT for the first six years of renting the property out.  After that time, the CGT clock is no longer frozen and starts ticking.

Unfortunately I don’t think that is the case for you.   However before you do any drastic changes and strategies, sometimes it is important to get an idea exactly how much CGT you are up for. 

Should you sell your property for $575,000, the raw $162,000 gain on paper is not fully taxable.  First you need to deduct incidental costs associated with both acquiring and disposing the property.  Let’s say that your include stamp duty, agent’s commission, property improvements and legal fees (on both sides of the transaction) comes to $42,000. 
This reduces your raw gain to $120,000.     Second, as you have owned the property for more than 12 months, you are entitled to claim a 50% discount so your taxable gain could be reduced to $60,000.  If you both owned the property then this gain is split and $30,000 would be added each to your taxable incomes and taxed at your marginal tax rates.  At 31.5% tax rate, this would be tax of $9,450 each to pay.  Ideally, pending market conditions, you would want to sell when you are on the lowest tax brackets, such as when you are retired.

If you move into your investment property, unfortunately it doesn’t eliminate your CGT obligation in full.  You would need to proportion any net gains made, on a daily basis, between the time the place was available for rent and the time that you lived in the property.  Hypothetically, if you moved in tomorrow and sell the place the next day then there is no real change in the CGT that you would have to pay.  If you moved in June this year and stayed there for 3 years, you are potentially saving half ($9,450) in tax.  But you are missing out on the $135 per week extra (or $21,060 over three years) you are getting in rent on top of what you are currently paying. 

If you do purchase another property to live in, the interest on that property is not tax deductible.  Whilst all debt is bad debt, you want to only have debt that is tax .  But if you are going to have debt then make sure it is tax deductible debt.  Pay off your non-deductible debt first and keep the investment property loan to the minimum of interest only. Once you have paid off all non-deductible debt start looking at extinguishing the tax deductible debt.

This article first appeared in the March 2012 issue of Your Investment Property Magazine www.yourinvestmentpropertymag.com.au. Copyright Key Media Pty Ltd 2012.