How property investors can avoid the traps and pitfalls of land tax
What is land tax? Who should pay it? And can I reduce this major property cost, which seems to eat into my rental income disproportionally?
These questions are often asked by the serious property investor who already has or is in the process of building a significant property portfolio.
The following article considers some of the traps and pitfalls while offering some suggestions on how to minimise this state-based tax.
In general, land tax is not levied on the property if it is your principal place of residence (PPR).
Land tax is an annual tax based on the ownership and usage of land owned at midnight on the land tax anniversary date of the state, which is usually either June 30 or December 31. It is levied in respect of the financial year immediately following that date. All states other than the Northern Territory apply land tax. This tax should be seen as a cost of doing business and is tax deductible.
As is the case for most taxes it is up to the taxpayer to advise the relevant state department that they are subject to land tax based on self-assessment by submitting either a land tax registration form or a land tax variation form. This will trigger land tax assessment notices to be issued if and when appropriate. Failure to advise can lead to significant penalties and back dated charges which the land owner may not be able to claim as a tax deduction.
Land tax is generally levied on the unimproved capital value of the land (not the total property value). Each state has different rules and thresholds of when the land tax will be applied. The threshold is the dollar value at which land tax will become payable. Below that figure no land tax is levied, and above it land tax commences at the prescribed rates. Most states have escalating rates as the land value increases so it is not proportional. In general there is a different rate and threshold for individuals and companies and a different set of rates for trust although in some states trusts are treated the same as individuals. The full land tax liability is therefore the land value multiplied by the applicable rate.
Exemptions are normally applicable to the principal place of residence, but only if it is being occupied as the PPR. If the taxpayer moves out (land tax form variation required) and uses the property as an investment property then land tax may be due even if it is still within the main residence six-year rule for ATO purposes. Other exemptions are normally available to agricultural use land and charities.
A PPR held in a trust may in some cases still be exempt if being used by a person with an approved disability and in some states an exemption or threshold is applied if the property in the trust is nominated as a PPR of the taxpayer. The rules for a PPR benefit within a trust are strict and need to be fully understood and met or the imposition of land tax will apply. Queensland has the easiest procedure (tick the box on the registration form), but while the property may be exempt from land tax it is not exempt from CGT on a sale, as this exemption normally only applies to individually held property. There are certain circumstances where the main residence exemption is applicable when a property is held in a trust but this is not discussed in this article.
In NSW and Victoria trusts with any discretionary capabilities do not get a threshold but in these states an approved fixed trust does receive a threshold if correctly worded and administrated. Superannuation funds in all states also receive the benefit of the threshold for property in that state.
An opportunity, however, does exist to manage the land tax liability for landholders by holding land in various individual, company and trust structures that are each entitled to a threshold. As land tax is state-based the tax is levied by the state where the property or land is located and a state does not aggregate land from other states when assessing. For example, land held in different companies would each be entitled to a threshold as long as management and control is different. Various states have grouping provisions which would also apply to trusts. Note that assets held in a company if sold do not get the 50% CGT general discount and for a waged employee negative gearing on a property held in a company cannot be claimed against personal income. Negative gearing against personal income is however available if the property or land is held in a Property Investor Trust®, which has an ATO Product Ruling (PR 2011/15).
Another trap is when property is in the name of more than one entity, say for example a couple. The couple are seen as a partnership and only one land tax threshold is available. If either of the people has land in their own right then at the secondary level only the proportion held together is included when determining the liability in total. No credits are available if the total liability at the secondary level is less than paid as a couple. For people with access to ongoing income (if negatively geared) it may be better to buy property in just one person’s name in order to get multiple thresholds. Long-term planning is therefore essential.
Land tax is payable by the current owner and not when it may have been applicable or levied. This can give rise to the new owner being liable for land tax when he or she did not “own” it. When purchasing land or property it is important to apply for a land tax clearance certificate to ensure you will not be liable for someone else’s tax or to give you the opportunity to have any liabilities adjusted at settlement.
Trusts can be a useful tool for both asset protection and estate planning. Widely used to hold property and with the ability to claim negative gearing against personal income (for some trusts), they have become a strategic tool for many property investors. States such as QLD, SA and WA have a relatively acceptable land tax threshold. While NSW does not give a threshold to a trust with a discretionary capacity this sort of trust may be useful when the individual exceeds the threshold in their own right. Most states have an upper limit on the total value of land held in an entity before they impose a surcharge on top of the normal land tax rates applicable, and so it may be beneficial to spread ownership between various entities if possible so as to not attract the surcharge. For example, in NSW the rate increases from 1.6% to 2% when the aggregate land value exceeds the premium rate threshold of $2.421 million (2012 year).
While not directly related to this topic it is important to understand that at a certain dollar value within a company or trust full transfer stamp duty applies as if the property was sold and not the more favourable stamp duty applicable to shares or trust units being sold. The ability to change control of a trust without triggering stamp duty in most states (given no change to legal ownership) is attractive as is the ability for investors to move into and out of trust without triggering full stamp duty. This has allowed many investors to work in joint venture together knowing if circumstances change to one investor then stamp duty would be minimised as opposed to a wholesale change to the legal owner if some of the joint owners wish to “buy” out the exiting partner. Unfortunately most states have an upper limit at which time changes to the ownership of a trust or company will trigger full transfer duty. Each state has different tests but by way of example in NSW landholder duty is triggered when the unencumbered land value exceeds $2 million in the company or trust. Landholders must register when the gross land value exceeds $2 million but the duty will only be applied to the unencumbered amount.
All states have a process for objection to a land tax assessments but this must be submitted on the proper form to the relevant person within 60 days from the date the assessment was issued. Objections can relate to any approved reason normally ownership, valuation and exemption. The relevant state websites show the process and documentation needed and should be immediately accessed if you want to lodge an objection as there are limited opportunities for discretion by the relevant commissioner if the 60-day test is not met.
Ken Raiss is a certified accountant and director of Chan & Naylor national accounting firm. Chan & Naylor offers a free five-minute question-and-answer session on its website under the "Ask the Experts" section.