Anyone who has watched a renovation reality TV show knows that a run down real estate nightmare could be a cash cow in disguise. It seems simple enough. Buy a fixer-upper, spend a bit of money on cosmetic changes, style the property and sell it for a huge profit! Many savvy investors with the energy and money to dedicate to such an enterprise, as well as the design flair to pull it off, have done this successfully for years.

But there are some pitfalls, and if you’re not careful, you can also end up paying a lot of tax. In this article, I will talk about the practical considerations you need to make before taking on a house flipping project, as well as explain how the ATO looks at property renovations and what constitutes a business. There may be significant income tax and GST considerations that have not been taken into account in a keen renovator’s budget, which may tip the scale in favour of long-term investment.

While the renovation shows on TV make house flipping look like an overnight success, the truth is, renovating properties does take a considerable amount of physical work and mental stress. Some renovation projects can drag on for months or even years, go over budget, and be met with resistance from neighbours (particularly in strata schemes) which can land you in NCAT proceedings and council disputes. In the worst case scenario, you may even be required to reverse the renovation.

Have a Plan

It is imperative that you have a business plan (whether you are in the business of property renovation, or just renovating your first property as a one-off project) before you even start looking for properties to buy.

The plan should include your cost budget, a time line for each phase of the project, and some property market research (specifically, who your target market is in that suburb, and determining the ceiling price for renovated properties of similar size and location to yours).
You do not want to over-capitalise on a renovation in an area where certain improvements will not necessarily add significant value for buyers (for example, splashing out on heated floor tiles in a suburb that has average year round temperatures of 30 degrees Celsius).
It is also a good idea to ask for advice from, or partner up with someone who has experience in renovations or property investment and development.
You will need to check council restrictions, zoning, heritage listing if applicable, and if the property is in a strata scheme or company title, that there are no by-laws that will prevent you from carrying out your plans (even minor renovations in a strata scheme may require a by-law to be approved at an owners corporation meeting).
You want to make sure you have deep enough pockets (i.e. cash or access to finance) to complete the renovation, in case unexpected circumstances arise which make you go over budget.
Lastly, is this something you think you have the skills and time to do? House flipping is a serious business and not usually something people do as a side-hustle. Consider the opportunity cost of earning a salary in a conventional job with all the benefits that entails.

In addition to all of the above, you then need to think about the tax consequences. The tax implications may significantly reduce your profit. Having the right entity structure from the start could potentially save you a lot of tax as well.

Personal Property Investor

This refers to home owners who renovate their own home or investment property and sell it for a profit.

If the property was your primary place of residence (PPR), then any gain you make is exempt from Capital Gains tax (you can treat the property as your PPR for up to 4 years prior to moving in, under certain circumstances).

If the property was held for more than 12 months, the owner may be eligible to a 50% Capital Gains Tax (CGT) discount on any gains (depending on tax residency status). However, beware of knocking down investment properties and re-building, or significantly changing the structure (substantial renovations), as this could create a CGT event in itself and attract Goods & Services Tax (GST) on the sale.

This sort of renovation is not generally considered “Property Flipping”, but worth noting because of the potential tax savings.

Property Flipping

Property Flipping is a term used to describe purchasing property and selling it quickly for profit. It usually involves renovating the property to add value, and a successful ‘flip’ will involve adding significantly higher value proportionate to the time and cost of the renovation.

ATO has 2 distinct categories for “property flipping”, but they are essentially treated the same way for tax purposes. The first is where you are conducting an activity for the purpose of making a profit, and the second is where you are running a renovation (or property development) business.

In both scenarios, the profit you make is treated as your income and must be reported in your tax return (or the return of whatever entity is conducting the business activity, e.g. a company or a trading trust).

Under this scenario, you will not be eligible for a CGT discount, even if the renovation took more than 12 months to complete. You cannot claim the profit against carried forward capital losses. You also will need to register for and pay GST on the sale value (you will be able to claim input tax on certain purchases, and may also be eligible for the margin scheme).

It is important to know the following before conducting any property flipping activity:

Does your activity have the nature of a business or carried out for the purpose of profit-making?
Are you required to register for GST? If so, this should be done ASAP so that you can claim GST credits on your costs.
Are you eligible for the margin scheme? If so, you must have made a written agreement with the purchaser before the settlement date (claiming the margin scheme means that you only include GST on a proportion of the sale price, not the whole amount).
How long do you intend to hold the property for after renovation or construction has been completed? If the property is a residential premises and you hold and rent the property for a continuous period of 5 years after construction has been completed, it is no longer considered “new residential premises” and will not be subject to GST (if you have claimed GST credits during the renovation or construction phase, you will need to amend prior Activity Statements and pay back the GST credits).
Lastly, but probably most importantly, what business structure will you use to purchase and renovate? Will you run the business through a trust or company? What kind of trust should you establish? Is it wise to use your super, or even possible? What are the benefits of one structure over another? These are the sort of questions that you need to sit down with a professional adviser and discuss.

Whether you are taking on a one-off renovation project, or starting up a renovation business, it is important to speak to a tax professional to make sure that you are not going to end up with a huge unexpected GST and tax bill at the end of the day. Feel free to reach out to us at any time for advice.

This article was written for My Property Circles.

If you would like to know more about renovating properties, have a look at the School of Renovating which is a great place to start learning the process, and connecting with like-minded individuals and potential equity partners.