This snippet is from one of our previous episodes: “Don’t Land the Plane During a Storm”: Should You Change Investment Plans?

In today’s bonus episode, we’re answering a question that’s on the minds of many property investors with business interests: How does Capital Gains Tax (CGT) work for commercial property, and how does it compare to residential?

Mark from southwest WA has done what many business owners dream of: buying a commercial property to house his business.

But while commercial property can be an excellent wealth-building tool (especially when you’re both the landlord and the tenant!), there are some important tax differences compared to residential.

In this episode, we clarify:

  • What counts as part of your CGT cost base
  • Why detailed record keeping is essential (and what to track)
  • The tax treatment of fit-outs, and who pays
  • The difference between tenant and landlord responsibilities when it comes to depreciation
  • That we’re not accountants… and it’s crucial to seek expert advice!

Is Your Property Strategy Tax-Smart?

Empower Wealth’s tax team is specifically trained in property and investment tax matters, so you’re not just getting a generalist… you’re getting a property tax specialist.

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Transcript

Bryce Holdaway
You made a really good point too before Ben, around having to navigate the typical thought that someone of this age profile has (that) is should have just spent it on a car. So if you can navigate that because there’s heaps of…

Ben Kingsley
Temptation.

Bryce Holdaway
Temptation… but statistical comparison around: oh, it’s so much better to buy an asset than it is to buy a car, right. But that ignores the fact that wisdom or experiences… that thing you get two minutes after you need it. So it’s not until you go through that, that you realize that’s what you should have done. So Anthony, if you can mentor your daughter into actually navigating that decision, where using that money on an asset rather than using it on a car… wow, that’d be an incredible legacy that you leave. And then I don’t know if there’s other kids, but if that becomes the model that everyone looks up to the big sister and says, wow, that’s what she’s doing. That’s what I’m doing. Wow, what a powerful family.

Ben Kingsley
Beautiful.

Bryce Holdaway
Good question, Anthony. Thank you for that. The next one is from Mark, Ben. This is a question around capital gains tax and commercial versus residential. So let’s have a little listen now.

Mark
Hi guys, Mark is my name. I live in a southwest town country in WA. I’ve been listening to your podcast for a couple of years. I haven’t got everything in place, although I do have a PPR and two rental properties. One rental property is a fixer-upper at the moment, which I bought at the start of COVID. My wife and I have a business, and we’ve just purchased a commercial property. I’m not sure whether this is in your wheelhouse or not, but listening to your podcasts for the last year… you’ve had people talk about tax and capital gains on residential properties. Is capital gains when you fit out a commercial property the same? Do you have to keep all of these records? And when you sell your property, does the fit-out cost come off or is that totally separate due to the fact that it’s a business as opposed to a building? Would just like your thoughts on that, if it is even in your wheelhouse. Thanks guys.

Bryce Holdaway
Good question, Mark. A couple things… we are not commercial tax experts, so we’re going to give you some ideas to explore with your suitably qualified accountant. So I just want to make that clear. Before we do, Ben, I love the part where Mark said that they purchased at the start of COVID. Wow. Like, let’s just pause and reflect on that. We’ve got a bunch of clients that did that, but that wasn’t easy to do. So we need to do a round of applause there, right.

Ben Kingsley
That is huge. I mean, this is where again, it sounds like Mark and what his wife are doing is exactly what we would say. They’ve organised themselves, they saw an opportunity, they’ve jumped in. They’ve also got a business, which is also an excellent vehicle to be able to build wealth out for financial peace and also contribution into the future. And it sounds like what they’ve done is seeing an opportunity to put their business inside a commercial premises. And so when you’re doing that, obviously the business will get a commercial lease in place with the company. So you will be getting rent. It should be obviously market rent in terms of what you’re trying to do there around having that income come in. So it’s a great way in which you can obviously build out potential capital wealth out of the commercial property and any of the improvements that you do on the building as part of that.

So definitely I would be saying to you Mark, you absolutely need to keep all of the records of everything that you’re doing. So if you’re improving the building, then those things would be part of the capital value. If you are looking at the fixtures and fittings, then again, there would be the ability for the wear and tear of some of those fixtures and fittings as well to be claimable as part of the amortisation of those particular assets. Now, in terms of capital gains tax, this is not my wheelhouse in terms of the difference between the two. So let’s just go through Bryce, what we have discovered.

Bryce Holdaway
Yeah, yeah, exactly. So there’s a couple things to think about. So let’s think broadly as an asset. Don’t worry about commercial. As an asset, you increase the cost base of your asset based on the money that you spend, right? So to give an example, we’ve got an office in North Melbourne, 610 square meters that we lease from the owner of the building. And then we had to pay for a fit-out within that building for ourselves, which includes The Property Couch studio and all of the other things. So the cost of the fit-out was a cost to our business, not the landlord. So therefore our accountant depreciates the cost of the fit-out to us, right?

But then if the owner of our building comes in and puts in air conditioners on the roof, or does anything to the building, that is a cost to them, not to us, that is a cost for them to provide the space that we have as a business. So therefore they would then put that onto their depreciation schedule, but it also formed part of their cost base as a capital gains tax item. So if you bought any other asset, you’ve got a cost base and then whatever the ATO says that you can add onto the cost base lifts the cost base. So your eventual sale price minus your ultimate cost base to pay tax on the difference. So that is the starting point here, right? And that is the difference.

So it seems like you’ve bought the premise for yourself, for your own building. So in the scenario I described for our business, we are not the landlord; we are the tenant. But you may be the landlord and the tenant, with your business acting as the tenant and you and your wife potentially are the landlords or whatever structure that you’ve put it in. So Ben is absolutely spot on that there… you absolutely need to keep the records. The best records give you the best chance of legally minimising your tax. So that’s the first part. So essentially, capital gains tax on commercial properties work in a very similar way to residential properties but there are some key differences. So I’ve got a list here. These are an acknowledged source they’re from realcommercial.com.au; it was a list that they had. They are the experts. Again, these are just ideas to get the juices flowing so that you can obviously have a conversation with your tax accountant, but unlike residential property, the owner-occupied commercial property is not exempt from tax, so you don’t get a CGT exemption from that. So that’s the one difference.

Companies are not eligible for the 50% discount on assets held longer than 12 months. So that’s another thing that you need to consider. And there are particular discounts and offsets available for certain types of property owners, which we’ll talk about in a second. Farms and home-based businesses are treated differently for tax purposes. So in addition to CGT, there’s some GST involved. So that’s just a couple of principles to think about. The discounts that we talked about previously was individuals, and trusts are eligible for 50% CGT discount on assets held for more than 12 months… so depending on that ownership structure. And if you’re selling your own premises, small businesses have an option of four different CGT concessions, including a 50% discount, a rollover, or a special exemption. So there’s a couple of things that you will need to consider, Mark. Hopefully that’s given you something to speak to your tax accountant around, for some tailored advice on the tax implications you get for commercial property.

But for the benefit of our listeners, we’ve had some people on to talk about commercial property. You are moving into a more sophisticated space, because residential property is the only investment market in the world not dominated by investors. That’s not the case in commercial because it is all investors and usually at a higher level of sophistication. So you need to understand what you’re playing at. But in this case, if your business is rock solid, you’ve got some blue-chip backing around being able to do that. My uncle has had his own commercial business in Fremantle. You’re in WA. He’s based in Fremantle, owned the building since 1980. And he also had the business within his own building. So he is in a similar position to you. And he’s now in a wonderful position that not only is the business in concern something that he can sell at some stage, but he also would be able to sell that business to the next proprietor of that. It’s a panel beater shop, a panel beater business. They could come in, continue to run the business and he would continue to collect the rent and obviously have opportunities to sell or keep going forward.

Ben Kingsley
And the other one that sometimes comes up here… and again, we’re not experts in this space, but with self-managed super funds, one of the rules is you can’t live in a residential property when you look to buy an investment property through a self-managed super fund. My understanding is and check this with your accountant, but there are rules around a self-managed super fund owning the business premises in which you run your business in. So again, that is a blanket statement. Check it out; make sure it’s correct with your tax accountant.

But those are some examples. It’s really good to understand that same with the individual and the trust, where it says as individuals and trusts, you’re eligible for the 50% capital gains tax. But if you’ve got a corporate trustee, which is a company trustee of that trust, just double check on that 50% capital gains exemption, because companies are not eligible for the 50% discount. So that’s also interesting there as well. So there’s definitely a few questions there that you want to be going back to your accountant with Mark, and see what you can do. And for the rest of the community, it’s not our perfect wheelhouse. We do our best in terms of general information but go and speak to the experts.