Property problems: Tax implications if status of rental property changes

Q: My wife and I bought a property back in 2001 as an investment to earn rental income (with a three-year rental guarantee). At that time, we were advised to register for the goods and services tax so that we did not have to pay for the GST on the purchase (as a partnership). Now our circumstances have changed and we are thinking of living in the property.

1. What implications are there on the GST since we did not pay GST at the outset?

2. Are there any other legal aspects we need to look at if we live in it?

3. We intend to dissolve the partnership after the transfer. Does this have any implications?

A: We assume the partnership did not pay GST on the purchase of the property because the property was sold as a "going concern"(ie there was a taxable activity carried on in respect of the property) and zero-rated for GST purposes.

It is common for apartment owners to lease their apartments to a hotel/serviced apartment manager who then makes the apartments available to the public for short-term accommodation. If an apartment owner sells an apartment subject to an existing lease with a hotel/serviced apartment manager, the sale of that apartment to a GST- registered person can be zero-rated for GST purposes as the sale of a going concern (as the apartment is used for a taxable activity).

In contrast, if a purchaser buys a property from a developer which is subject to a lease with a residential tenant, the sale of the property cannot be zero-rated for GST purposes as the property is used for residential accommodation (ie the property is not used for a taxable activity).

Further, if the purchaser continues to rent out the property for residential purposes after the purchase, the purchaser cannot register for GST as the rental activity will not be a taxable activity and cannot recover any GST charged on the purchase of the property. However, there would not be any GST implications if the purchaser subsequently used the property for private purposes (although there could be income tax implications in relation to tax depreciation previously claimed, see below).

In response to your first question, the partnership will be liable for GST when the property is used for your personal residence, as the partnership will cease to carry on a taxable activity at that point. The amount of GST will be one-ninth of the open market value of the property at that time.

The change of use of the property will also have income tax consequences if you and your wife have claimed tax depreciation in respect of the building component of the property.

A change to private use is a deemed disposal of the property at market value on the first day of the next income year for depreciation purposes. You and your wife will derive taxable income to the extent the market value of the building is greater than the tax book value of the building at the time of the deemed disposal.

However, the amount of taxable income will not exceed the tax depreciation previously claimed. This is known as depreciation recovery or clawback.

For example, assume the property cost $200,000 (made up of land $80,000 and building $120,000) and tax depreciation of $21,600 has been claimed by you and your wife in the six years to March 31, 2007.

If the change to private use occurs on March 31, 2007, and the market value of the building component of the property on April 1, 2007, is more than $120,000, you and your wife will have taxable income of $21,600 in total in respect of depreciation recovery for the income year ending March 31, 2008.

The same depreciation recovery issue also applies to any chattels in your rental property and subsequently used for private purposes, but these will have lost value over time.