Beware 'flipping' for profit

By Duncan Hughes, AFR, 7-8 July 2018

Nervous investors are rushing to sell residential properties because of growing fears of falling prices, rising costs and worry the sales downturn will turn into a slump, stranding them with big debts and few options. Property professionals claim there is a spike in investors rushing to complete renovations, subdivisions or planning approvals and have their properties listed for a quick sale. But the high cost of short-term finance, marketing and sales expenses, potential capital gains and GST liabilities could turn investors’ preparations for their golden goose into a turkey.

“Selling into a falling market is a real problem – it’s really dangerous,” warns Louise Lucas, chief executive of The Property Education Company, a mortgage broker and buyer educator.

The seven year property boom has created a generation of renovation junkies hooked on the promise of big financial gains from rapid transactions based on buying, renovating and selling. It’s called ‘flipping’ or short-term property trading involving buying undervalued property and reselling at a higher price, buying property at market value and riding the capital growth curve, or adding value to the property through renovation, subdivision or development approval.

In the 12 months to June 30, 2017, about 4000 dwellings were sold having been owned for less than a year and a further 17,000 resold after being owned for between one and two years, according to CoreLogic, which monitors property prices. That’s between 2 per cent and 6 per cent of total sales for that period.

What’s spooking the market now is eight successive months of falling national house prices to the lowest level in five years, big falls in auction clearance rates and the number of days on market ticking up one day to 44. Sydney, which until recently was the nation’s hottest market, has also overtaken Brisbane for the biggest vendor discounts, typically about 4.5 per cent, according to investment bank Morgan Stanley.

A big surge in newly constructed properties coming on to the market – particularly inner Melbourne, Brisbane and Sydney – is also putting pressure on prices at a time when overseas investment has been cut by government bans.

Amy Mylius, a buyers’ advocate with Cate Bakos, also warns investors against rushing into selling in a falling market. “Flippers do not generally make money,” Bakos says. “They are sometimes lucky but that’s a case of selling at the right time of the market to the right buyer.”

Lenders are also generally reluctant to finance flippers, who typically seek short-term unsecured loans with rates north of 10 per cent, which is twice the rate on secured offers.

Jarrod McCabe, a director for Wakelin Property Advisory, also warns novices will be punished by not knowing where to buy and what is going to add value at minimal cost. “There is a heavy reliance on the property performing well,” says McCabe. “Time and time again, we see vendor expectations well above what the market is willing to pay.”

The selling costs of a typical $1 million house will include: about 2 per cent ($20,000) for estate agent fees; 1 per cent ($10,000) for advertising costs; a further $1,000 for conveyancing; property preparation costing $10,000, and $1,000 for furniture storage/replacement. That’s a total of $42,000.

Flippers are also likely to attract interest from the Australian Taxation Office, particularly following recent changes to GST and CGT rules. For example, a transaction involving a flipper who buys a property and renovates with the intention to sell for a short-term profit will be considered as a speculative or business activity, even if it’s just a one-off deal.

“Even if this does not have the repetition which is usually required to be deemed to be in business, this can still be treated as a profit-making venture, with any profit made being taxed as normal income,” says Andrew Burns, a manager and tax consultant with HLB Mann Judd. There will be no access to the 50 per cent capital gains discount, no matter how long the property has been held.

“While it is likely to be considered an enterprise for GST purposes, the sale will only be subject to GST where there are substantial renovations to the property,” says Burns. “This will generally require changes to the actual structure of the building rather than merely replacing components such as the kitchen or bathroom.”

Another popular scenario is where the investor buys with the intention to rent out but decides to sell. “The property will be an income-producing asset, therefore any profit realised on its eventual sale will be taxed as a capital gain,” says Burns. “This will include the 50 percent capital gains tax discount for assets held for more than 12 months.”

In addition, renovation costs are not immediately deductible but added to the cost base for determining the capital gain. Depreciation can be claimed on items such as stoves, hot water services and security systems that are installed as part of the renovation. “There will be no GST on the eventual sale as there has not been any enterprise carried on,” says Burns.

Investors who renovate then sell a property previously held as a rental property should also allow for CGT in assessing their income. “The property was an income-producing asset, and the renovations prior to sale will merely be to get the property ready for sale and to maximise its value,” says Burns. “Therefore any profit realised on the sale will still be taxed as a capital gain. This will include the 50 percent discount for assets held for more than 12 months.”

Renovation costs will not be deductible but will be added to the cost base of the property when calculating the capital gain. “The renovation and sale will be treated as the mere realisation of an asset which has not been used in a GST-registered enterprise, and will not amount to an enterprise in its own right,” he says. “Therefore there will be no GST on the sale.”

CGT for an individual is the same as your income tax rate for that year. For self-managed superannuation funds, the tax rate is 15 per cent and discount is 33.3 per cent, rather than 50 per cent for individuals.

In most cases GST is calculated by dividing the price by 11.