In an era of decreasing homeownership and rising property prices, many parents are helping their children to purchase property, often as joint owners. Lawyer TERRY MORGAN advises caution; parents could be hit hard by capital gains tax.
A joint ownership arrangement can create a Capital Gains Tax (CGT) trap for the parents. The child pays no CGT and will be exempted from tax because the property becomes their principal place of residence. However, the parents cannot use the principal place of residence exemption because they live elsewhere.
If parents helping their children to purchase a home do so through joint ownership, then a custodian trust deed may be used to avoid the capital gains tax trap. Alternatively the parents should consider forgoing joint ownership and utlise a loan arrangement. The loan can be secured by a mortgage or a caveat registered on title of the property thereby protecting the parents’ interest in the property.
A recent decision of the Administrative Appeals Tribunal (AAT) (Gerbic v FC of T (2013)) reviewed three arguments to avoid the capital gains tax trap on the sale proceeds of a townhouse, which was jointly owned by a father and his son.
The facts in this case are that the father purchased a townhouse in Queensland in April 2002 for his son in which to reside. He purchased the property in his and his son’s name as joint tenants.
The father used his own funds to purchase the townhouse. The son made no contribution towards the purchase price nor did he pay any rental. In an effort to protect the father’s money and give him some control over the property, he became a joint owner of the property.
His son lived in the townhouse and paid the council rates, strata levies, electricity and telephone bills as well as paying for bathroom improvements and a new water heater.
When the townhouse was sold in September 2007, the Commissioner of Taxation assessed the father for 50% of the net capital gain arising from the sale. The argument the father raised to avoid the capital gains tax (CGT) trap was: Does buying a property as joint tenants mean that the son’s main residence exempt, or can cover all of the capital gain?
The argument rested on the fact that the father and son held the title as joint tenants. Joint tenancy means owning the whole of the property jointly. It is like owning a whole apple jointly – each has ownership of the whole apple.
The argument might have succeeded but for Section 108-7 of the Income Tax Assessment Act 1997, which provides that individuals who own a capital gains tax asset as joint tenants are treated as if they each owned a separate capital gains tax asset. This means that they are treated as having separate interest as tenants in common in equal shares; it is like owning one – half of an apple, after it has been cut in two.
First, “Is capital gains tax payable only if there is a profit making intent?”
The argument was put that the joint ownership of the home was intended to protect the father’s “inexperienced” son from doing anything “silly” such as selling “on a whim”.
The AAT decided that intent was not relevant. Therefore, no profit making intent is needed for capital gains tax to be payable. Nor was it relevant that the father directed that the proceeds of sale be paid to reduce bank debt on another property. He was treated as if he received the money.
Second, “Did the father hold his half share as trustee on trust for his son?”
It was argued was that the capital gains tax provision did not apply to the legal owner, if that owner held the asset in trust for someone else.
Tax law recognises this argument if a beneficiary has an absolute entitlement to an asset, as against a trustee under a trust.
The father argued this principle on the basis that although he was registered on title as the legal owner, his son had the equitable (beneficial) interest in the property.
This argument might have succeeded but for the fact that the father was unable to produce a Bare Trust Acknowledgement or a Custodian Trust Deed, signed by him and his son prior to the purchase. The father could not argue that a Constructive Trust had been created, as his son had paid no rent or other money towards the purchase.
The result was that the AAT rejected all of these arguments and upheld the tax assessment on the father to pay a 50% share of the net capital gain.
Conclusion: how to avoid the tax trap
The joint ownership structure that the father used to buy the townhouse as a home for his son was not effective to qualify for the main residence exemption nor any other exemption. Therefore, the father was caught by the Capital Gains Tax trap.
If a parent requires joint ownership then a Custodian Trust Deed may be used to avoid the Capital Gains Tax trap.
Alternatively a parent must forgo joint ownership and use a loan arrangement. The loan can be secured by a Mortgage or a Caveat registered on the title of the property thereby protecting the parent’s interest in the property.
