Many clients make the assumption that any gain made from the activity will be exempt from tax as long as the property is their main residence for the entire ownership period. However, this is only the case where the property is held on capital account.
The ATO guide indicates that someone who is renovating a property with the intention of selling the property again at a profit could be taxed on revenue account in which case the main residence exemption is no longer applicable.
The ATO identifies three main scenarios and the general tax implications as follows:
- Personal property investor – this is someone who purchases a property with the primary intention of using it as a long-term rental property or private residence. If this person undertakes some renovation activities and then sells the property earlier than originally planned then they should still generally be able to argue that the sale is dealt with on capital account, which means that the main residence exemption and/or CGT discount could apply.
Example
Douglas is a sales representative. He obtains an investment loan and purchases a property that he intends to rent out. He would not consider selling the property unless the price appreciated markedly. The property requires renovation to attract desirable tenants. Douglas renovates the property after work and on weekends. Over the period of the renovation, the real estate market booms and Doug decides to sell the property.
Douglas would not be considered to be in the business of property renovation because his intention when he bought the property was to gain rental income rather than make a profit from buying, renovating and selling it. Douglas didn't rely on the income to meet regular expenses because he has income from his job and his renovation activities were not carried on in a business-like manner. Douglas did not buy the property with a view to selling it at a profit, and did not carry out a one-off profit-making activity. So, Douglas is regarded as a personal investor.
However, if Douglas, because of his success with this renovation (either in his own right or with another or others) was to then undertake another renovation similar to the first with a view to achieving the same profit levels, he will be regarded as being in the business of property renovation.
- Isolated profit-making undertaking – this is someone who buys a property with the primary intention of carrying out renovation activities and then selling the property when the work is completed. Someone in this category is likely to be taxed on revenue account with no access to the main residence exemption or CGT discount.
- Business of renovating properties – this is someone who undertakes property flipping activities on a regular or repetitive basis and where the activities are organised in a business-like manner. As with the category above, there is generally no access to the main residence exemption or CGT discount.
Just because someone may live in the property for all or part of the ownership period does not automatically mean that profits on sale are exempt from tax. The main residence exemption can only reduce capital gains, it cannot reduce amounts that are taxed on revenue account.
PROFIT-MAKING ACTIVITY OF PROPERTY RENOVATIONS
If you're carrying out a profit-making activity of property renovations also known as 'property flipping', you report in your income tax return your net profit or loss from the renovation (proceeds from the sale of the property less the purchase and other costs associated with buying, holding, renovating and selling it).
You're entitled to an Australian business number (ABN) and you may be required to register for GST if the renovations are substantial.
Example: Renovation as a profit-making activity
Frank and Sarah are married with two children. They renovated their home, substantially increasing its value. After watching many of the home improvement shows and seeing how other people have bought, renovated and sold properties for a significant profit, they decide to investigate the purchase of another property to renovate and make a profit.
They consider many properties, costing out the renovations, the costs of buying and selling and timeframes to complete the renovations. Their research shows that they could also make a significant profit.
Frank and Sarah sell their current home and purchase a new property, which they move into while completing the renovations. They plan out the renovation in stages, including the costs and any contractors needed to complete the work. The renovation runs to schedule and, when completed, they list the property for sale and it sells for a profit.
Because the property renovation activities were planned, organised and carried on in a business-like manner, the purpose of buying the property was to renovate it and make a profit, and the renovations were carried on in a similar manner to other property renovation businesses, Frank and Sarah have entered into a one-off profit-making activity.