Helping kids can land parents with a tax bill

Parents often like to lend a helping hand to their children, even when they are adults.

This can range from a few dollars to buy some furniture, to a lot more dollars to buy a car, and even heaps more dollars to help buy a property. The kids should be eternally grateful! But wait, there’s a potential tax sting in the tail as a recent decision of the Administrative Appeals Tribunal (AAT) highlighted.

In that case, a father purchased a townhouse at Mount Coolum in Queensland for his adult son to reside in. To guard against his son “acting unwisely”, the father had the property transferred to himself and his son as joint tenants.

The son Justin lived in the townhouse until 2007, when he moved into a house at Coolum Beach. The Coolum Beach property was purchased by the son and his mother, and was financed through a loan from Westpac secured by a mortgage over each of the properties.

In September 2007, the townhouse was sold and the proceeds of sale were used to reduce the debt to Westpac. At the same time, Westpac released the father from a guarantee he had given.

So where’s the tax problem … and for whom? The father was assessed for the 2008 income year for capital gains tax (CGT) on 50% of the net capital gain arising from the sale of the townhouse. His objection to that decision was disallowed by the Tax Office and he appealed to the AAT.

The AAT said there was no dispute that the townhouse was sold for a capital gain or as to the amount of that gain. But who gets assessed to that gain?

Under the tax law, individuals who own a CGT asset, like the townhouse in this case, as joint tenants are treated as if they each owned a separate CGT asset, constituted by an equal interest in the asset, and as if each of them held that interest as a tenant in common. That is, a 50:50 share by each of father and his son.

The father argued that it was never his intention to profit from the sale of the townhouse. He said he only went on the title to protect his “inexperienced” son of 23 years from doing something “silly” and selling the townhouse on a whim.

That may all sound entirely reasonable and prudent, but the tax law is strict. The father’s aims in becoming a joint tenant, however admirable, do not alter his liability under tax law, as an owner of a half interest in the townhouse, for CGT on 50% of the capital gain on its disposal.

The father also said he did not receive any of the proceeds of sale of the townhouse. After payment of expenses, such as agent’s commission and legal fees, everything went towards reducing the loan used to purchase the Coolum Beach property in which he had no interest.

The AAT said that, as a joint tenant, he had an entitlement to half the proceeds of the sale. His decision to use his share of the proceeds to reduce the debt to Westpac was his choice. For CGT purposes, a person is treated by the tax law as having received money if it is applied as he or she directs. The tribunal came to the conclusion that the father made a capital gain in respect of the disposal of his half interest in the townhouse, and the assessment should stand.

The CGT provisions in the law do not apply to the legal owner of an asset if the legal owner held it on trust for another person and the other person was absolutely entitled to that asset as against the trustee. Was this helpful to the father? Unfortunately not.

The father said that if he had known of his potential liability, he would have signed a trust deed declaring that he held his interest in the townhouse on behalf his son. The AAT said that may well have defeated the purpose of having the title in both names, but the father conceded there was no written declaration of trust.

The law provides that a capital gain made from the disposal of a dwelling will be disregarded in the case of an individual, if the dwelling was his or her main residence throughout the period of ownership. While the son actually lived in the townhouse, and would have been entitled to that exemption in respect of his interest in the property, the father did not reside there and was therefore not entitled to the main residence exemption. The AAT noted that it was not sufficient that it was a co-owner’s (ie. the son’s) main residence.

The best of intentions aside, getting involved in trying to help children with property is fraught with potential traps – tax and otherwise. It may be difficult, but beware of the heart ruling the mind! The consequences of this can be costly. Tax is often lurking behind the scenes of many transactions that people might simply not be aware of. It’s prudent to get professional advice. For those wanting to know more about how CGT works, the forthcoming Thomson Reuters CGT Guide for SME Practitioners is very helpful. Among other things, it explains how CGT rules are applied to transaction-based issues, and contains useful tips, warnings and checklists.

Terry Hayes is the editor-in-chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions. Featured product is the 2013-14 edition of The Essential SMSF Guide, written by Tony Negline – see details here.