Thinking of selling your investment property?
Don't take the plunge before you read the whole article
Property prices are booming in Wagga Wagga as they are in most other regional towns post Covid (Yardney, 2020). That is good news for a lot of people who want to sell their properties. It is certainly a seller’s market these days.
It is perhaps the most unexpected outcome to the Covid crises which left many people unemployed. According to the figures published by the Australian Bureau of Statistics, nearly seven hundred and fifty thousand people were unemployed in March 2020. By the time it was July 2020, the figure rose to over one million. (Australian Bureau of Statistics, 2020) By December 2020, the total unemployment figures still stood at eight hundred and sixty thousand. (Australian Bureau of Statistics, 2021) This was in line with the fall in GDP and GDP per capita through December 2019 to June 2020 after which it rose again in the September quarter of 2020.
Another surprising piece of information to go with the above is that the household wealth actually increased in the September quarter by 1.7% and was mainly the result of increased deposit accounts and increase in residential assets. (Australian Bureau of Statistics, 2020)
Perhaps then, it is not very hard to draw the conclusion that the Covid incentives combined with the falling rates of interest have gradually pushed the real estate market upwards.
The next question is how long will this boom last? It is my opinion that if the rates of interest are not raised, things will keep looking good for property.
Tax and property
Being a tax accountant, I am probably the first person my clients think of when they have an investment idea (apart from your mate who discussed investment property with you at the pub on Saturday night “I was offered eight hundred and fifty for my rental at the lake! It’s gone up by 150K over the year!”)
This is a real story. No joking! Follow on.
Anyway, I have a client who was contacted by a property agent this weekend and offered an unbelievable amount of $900,000 for a rental. She was ecstatic. “This is insane!” she said. “I don’t believe it!” “You have hit the jackpot! Well done, congratulations!” I said. “Now I can go on the cruise once the vaccines get going, renovate my home which badly needs a new roof AND LIVE THE LIFE..never having to think before spending!” In that moment I figured out that I had to do some quick thinking before the sackful of cash was tossed up in the air.
I could probably hate myself for what I did after that.
“How much did you buy the property for?” “Why, six hundred and fifty a few years back.” I could sense that she was sobering down a bit.
“Don’t tell me the ATO could come after me,” she said.
“I know your tax slab is 37.5%.” I said.
“What do you mean?” she asked.
“Well, if you bought the house for six fifty and sell it for nine, you would have made a capital gain of two hundred and fifty thousand dollars. Capital gain is added to your regular income which you get from your salary. In that case, your tax slab would go up to 47% which is the highest slab. What that means is that you would probably end up paying around seventy thousand dollars in tax this year.”
“How much money would be left with me?” She was still hopeful.
“How much loan do you have on the house?” I asked.
“Five hundred and eighty thousand.”
“Well, out of the nine hundred thousand, you would pay sales commission to the property dealer which could be upwards of ten thousand, pay seventy thousand to the tax man and then pay five hundred and eighty to the bank. At the very least, you would pay out six hundred and sixty thousand. But you would be left with a very substantial two hundred and forty thousand.”
Needless to say, my client was not very happy.
She was going to lose a rental property which paid her an income every month for a total of two hundred and forty thousand. This would not even be able to pay off the loan for her own home fully.
Things to consider before selling
There are a lot of things to consider before you sell off your property.
Some of the issues which need to be thought over are intense and thought provoking. If you are planning to sell off your investment property, please make a note of all the things listed below and try to answer them as truthfully as possible.
1. A property when fully paid off, is like an earning member of the family. It keeps providing you with an income even if you don’t go to work. It does not scream at you for any reason and keeps giving day after day after day. How much rent would your rental property yield when fully paid off? What percentage of your income is that amount? For most people, if a rental property yields around twenty five thousand a year, that is nearly 50% of their wages. It is a lot to supplement your income and provide for you when you are not able to work. What is the value of that income? Let’s say, my client was to get two hundred and fifty thousand after the sale. That would amount to 10 years of rent that she could get on that house in advance. But that would work out only if she were disciplined enough not to use up the money for things which were “wants” and not “needs.” Further, if she retained the house, the rent would keep up with the rising prices whereas the cash would dwindle. We all know from the time that we were growing up that 50 cents was a lot once upon a time. Now you could not buy anything for fifty cents at the supermarkets. Whereas if you look at the family home you would have grown up in, has increased in value over the years. It has kept up with the inflation.
Be brutally honest with yourself. What do you need in the coming few years? Income or a lumpsum of cash.
2. What stage of life are you in? Are you close to retirement or are you still in your thirties? A great retirement needs planning for at least 20 years. How much money would you need to comfortably retire? If you are close to retirement, selling your investment property to pay off your own home would be a great idea. Besides, when you retire and cut down your hours of work, your tax slab would be very low. Hence, the capital gains tax which you need to pay would reduce greatly too! So, it would be a win- win situation. However, if you are in your thirties and want to sell of your investment property to upsize your home, that is great too! That is so because, you are using the money to invest again. I am not against holidays and cruises but those need to be planned for using your disposable income. It is not very prudent to sell your house and go on a cruise. That is because a house is like an earning member of your family and a cruise gets over in a few days, leaving only the pleasant memories behind ..something like killing the goose that lays golden eggs (in our case, just eggs)
3. Is your property providing you with an income or is it a negative gearing property? Are you able to afford the outflow if it is a negative gearing property or not? If the financial burden is too high and is interfering in your day to day life, discuss it with your accountant and financial planner and see what is the best outcome that can be achieved. What if your property is a commercial property which was knocked out after Covid? Again, don’t decide anything without professional help so that you know what are the various scenarios and outcomes that you can go in for.
4. How long have you held the property for?
If you have held the property for less than a year, you will not be able to avail of the capital gains discount. What that means is that if you sell the property after holding it for a year, the capital gain will be reduced to half. Here is an example. Lets say my client was making a capital gain of $250,000 ($900,000 less $650,000) Had she bought the property less than 1 year ago, the capital gain would be calculated like this: Lets say she is on the 37% slab. She would have to pay a tax of $92,500 ($250,000*37%).
However, if she had held the property for more than one year, this amount would be reduced to half i.e., $46,250.
5. What if your property is a business property? By that I mean it could be an asset used by the business like office premises, shops, parking lots and farmland. These are special categories or property which can have capital gains concessions applying to them. That is a very specialised topic and would need entire paper devoted to them. Again, in order to get the maximum benefits out of your property, please see your accountant. Ideally, your accountant should be kept in the loop at least a year or so before your decide to sell so that you can be advised of all the benefits that you can avail with a little planning.
What is the price you are being offered for your investment property?
What did it cost you to make or buy?
How many years have you held your property for?
What is the loan left?
Have you paid off your own home loan?
Do you own the property by yourself or jointly with someone else?
What is your age?
When do you plan to retire?
What do you want to do with the money you get?
When you sell your property, how much money will actually hit your bank after the mortgage has been paid and the taxes have been settled?
For your financial wellbeing, would you rather have an income or would you rather have a lumpsum of money?
Put down the reasons for each below.
Reasons for lumpsum
Reasons for monthly income
My Client’s Decision:
Anyway, after this huge winding discussion with my client and thinking about her choices and particular life situation, she decided that it would be best for her if she sold her property and paid off her own home. Of course, if she did that, she would not be able to live the life of a millionaire but there would be a lot more financial stability in her life.
And she is going to do that next year when she cuts down her hours and plans a baby.
I am delighted by the outcome as it is a well thought out plan which takes into account her particular situation.
My message to the readers:
The purpose of this article is to get you to think about your financial situation. Tax strategies are a very powerful tool for you to make use of to improve your financial situation and create abundance in your life.
This is general advise only. This a general educational article for highlighting all the issues you need to think about before selling your investment property.
As an accountant, it our job to advise our clients about the tax outcome of any option they go for. When you are not sure of something, make it a point to talk to your accountant before you sell your investment property.
Australian Bureau of Statistics. (2020, December 17 ). australian-national-accounts-finance-and-wealth/latest-release. Retrieved from https://www.abs.gov.au/: https://www.abs.gov.au/statistics/economy/national-accounts/australian-national-accounts-finance-and-wealth/latest-release
Australian Bureau of Statistics. (2020, August 13). Understanding unemployment and the loss of work during the COVID-19 period: An Australian and International perspective. Retrieved from https://www.abs.gov.au/: https://www.abs.gov.au/articles/understanding-unemployment-and-loss-work-during-covid-19-period-australian-and-international-perspective#unemployment-and-job-loss-in-australia-during-the-covid-19-period
Australian Bureau of Statistics. (2021, January). Labour Force Australia, latest release. Retrieved from https://www.abs.gov.au: https://www.abs.gov.au/statistics/labour/employment-and-unemployment/labour-force-australia-detailed/latest-release
Yardney, M. (2020, December 15). What’s really behind rising house prices? Retrieved from https://au.finance.yahoo.com/: https://au.finance.yahoo.com/news/why-are-house-prices-still-rising-200018097.html?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAALp8VSlBrJoMlDE-fsftD0nILA9xSS3upjkefQul9O1844Xxzx53jzw_zzczE2lzsJTCgdFYx9MPu9tjTCkHkh4NaTZ