Vendor Finance

Dave,
Just some information on the tax effect of the transaction to make sure you know what you are getting yourself into:
If the Vendor Finance arrangement has the following features the income stream received, once the wrap arrangement has begun, is considered to be principle and interest by the ATO. The income stream received before the wrap arrangement is entered into is considered rent. Reference ID2003/968.
Typical Features of a Wrap (Vendor Finance Arrangement)
1) The purchaser pays a deposit at the time of entering into the arrangement.
2) The settlement (change of the title deed to the purchaser) does not take place for several years after the arrangement is entered into.
3) The purchaser has the right to occupy the property prior to settlement
4) The purchaser pays a weekly amount (regardless of the name it is given in the arrangement) for the right to occupy the property
5) As part of the arrangement the purchaser pays the rates, taxes and insurances on the property.
6) The balance of the purchase price to be paid on settlement of the arrangement is reduced by the weekly instalments.
7) If the purchaser fails to complete the arrangement the deposit and weekly instalments are forfeited.

Now what about the profit on the sale of the property? Is that normal income or capital gain and when is it taxable? Assuming an agreement similar to that described above the answer to this question revolves around whether the vendor is in the business of selling houses or an investor just realising an investment. The key issues in differentiating here, according to ID2004/25, 26 & 27 are:
1) The Vendor did not use the property for any other purpose than to enter into the wrap. A straight rental of a property before entering into a wrap arrangement would avoid this point.
2) The property was sold at a profit
3) The wrap arrangement was entered into within 6 months of the vendor purchasing the property.
4) The Vendor is in the business of purchasing properties to resell. It would be difficult for the ATO to argue this case if the Vendor only bought and sold one property.

If you are caught by all of the above then CGT cannot apply to the sale of the property as the profit on the sale is revenue in nature. If a transaction is caught as income, CGT does not apply or in other words CGT is the last option if income tax doesn’t catch it. But even if you weren’t caught by the above and CGT applied there would be no discount if the property was held for under 12 months. If you did hold the property for less than 12 months before entering into the wrap it is better to argue that you are in business and caught by the above because the profit on sale would be revenue in nature and as a result not assessable until settlement which could be 25 years away (ID2004/27). If you hold the property for less than 12 months but it is subject to CGT you don’t qualify for the discount but would be assessable on the profit when entering into the wrap.
Section 104-15(1) of ITAA 1997 states that a CGT event happens when the owner of a property enters into an arrangement with another party to allow them to live in the property and title may transfer at the end of the arrangement. Section 104-10(3) states that the time the CGT event happens is the time of entering into a contract for the disposal of the asset, not when settlement (title passes) takes place.
For example this means that the vendor who enters into a wrap on a property that has been previously used as a rental and held for more than 6 months will be subject to CGT on the property in the financial year the wrap agreement is entered into. Accordingly, if at this stage the property has not been held for 12 months no CGT discount will be available even if they eventually end up holding the property for 25 years under the arrangement.

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Jobee,

Normally what happens is the wrapper takes out insurance, and then charges the wrappee for it…..

Scott

Pelican Investments
http://www.pelican-invest.com

>>You could just get a couple of valuations done (and average them), and add your margin to this (20%) for the tenants purchase price.<<

I would have thought from all the reading I’ve done that usually the wrapper endeavours to buy the property below what the market value is and thence add a margin on. !!??

I do realise of course that in this particular case the vendor already owns the property.

A 20% margin on top of the market value seems rather hefty to me. ?

Another way of doing it is as follows :
Some 20 years ago I ran into a vendor who wanted to sell a property and the price is left open, being determined at the time of purchase + say 5 years, with the profit (being the difference between the valuation figure in 5 years time and the value of the property at the time of the agreement) beign shared equally between the vendor and the purchaser.

In the meantime the tenant/buyer is paying rent to the vendor at a higher rate than normal and this excess part of the rent is put towards the deposit for the buyer in 5 years time.

The vendor in the meantime has a tenant/buyer in the premises who one would expect will look after the property.

A win/win situation all around.

Pisces