Overview
John and Marie, in their early 50s, own a principal place of residence with a large block of land. They were approached by a developer with a proposal to subdivide their land, demolish their existing house, and build a new house for them. The building cost will be approximately $1.5Mil and additionally, the developer offered a cash sum of $250,000. In return, the developer would retain the vacant portion of the property, build a house on it, and sell it immediately upon completion of the development. The developer assured John and Marie that they would cover all costs related to subdivision, GST, and tax on the profit from the sale of their portion of the land. Since this is John and Marie’s principal place of residence, they were informed by the developer that they would not have to pay any tax or GST on these transactions.
John and Marie were intrigued by the offer, but it seemed too good to be true. To ensure they fully understood the tax implications, they reached out to Investax Group for professional tax advice.
The Challenge
The primary challenge in this case revolves around determining if any of the transactions constitute a sale. For a sale to be taxable, it must be made for payment, which can be monetary or in another form, such as:
- Goods or services provided instead of money (barter transactions)
- Payment in the form of refraining from doing something
Understanding Barter Transactions
According to the ATO, in its simplest form, bartering involves the direct exchange of goods or services for other goods or services without reference to money or money value. Barter transactions are assessable and deductible for income tax purposes to the same extent as other cash or credit transactions. When an entity that is a member of a trade exchange makes a taxable sale to another member, there is a liability for tax, including GST.
Is the Exchange of Goods Considered a Taxable Sale?
John and Marie’s transaction with the developer is indeed considered a taxable sale. This is because the agreement involves a barter transaction where the developer provides goods and services (subdivision, demolition, construction of a new house, and a cash sum of $250,000) in exchange for the vacant portion of John and Marie’s property. According to the ATO, barter transactions are assessable for income tax purposes, just like cash or credit transactions. Since the developer’s proposal includes a form of payment—both monetary and in the form of construction services—this constitutes a taxable sale, making John and Marie liable for tax implications associated with the transaction.
Are You Liable for Capital Gains Tax (CGT) When You Subdivide your Principal Place of Residence (PPOR)?
Generally, Australian residents receive a main residence exemption (MRE) when they sell their principal place of residence, which means they are not liable for Capital Gains Tax (CGT) on the sale. However, this exemption does not apply in the case of subdividing the land. Even though John and Marie are not directly engaged in subdividing their property, the developer is undertaking the subdivision. The developer will keep the vacant portion of the land with the intention to sell it in the future. In return, John and Marie will receive a newly built house worth $1.5 million and a cash sum of $250,000.
Since the vacant land being sold does not contain their dwelling, John and Marie will not be eligible for the main residence exemption on this portion of the transaction. Therefore, the capital gain on the sale of the vacant land will be subject to CGT. This is a crucial consideration for John and Marie, as it affects the overall tax implications of the developer’s proposal, impacting their financial outcomes significantly.
What Will Be Considered as Income for John and Marie?
Based on the information provided, the income for John and Marie from the developer’s proposal will include the newly built house and the cash sum they receive. The newly constructed house, valued at $1.5 million, and the cash payment of $250,000 will both be considered as forms of compensation. This compensation is given in exchange for the vacant portion of their subdivided land, which the developer will retain and sell. The value of the new house and the cash sum received are assessable for income tax purposes. As such, these amounts will be considered as part of John and Marie’s taxable income, reflecting the fair market value of the benefits they received from the transaction with the developer.
Is the Property Subdivision a Profit-Making Activity or Capital Gain?
The difference between a profit-making activity and a capital gain when it comes to selling a subdivided block of land is a complex matter. This distinction hinges significantly on the intention and the nature of the activity. Profits from isolated transactions are typically considered income when they occur outside the ordinary course of a taxpayer’s business, particularly if the primary intention was to make a profit.
For John and Marie, the developer’s proposal can be seen as an isolated transaction entered into with the intention of making a profit, as per tax ruling TR 92/3. They are not regularly involved in property development, but the transaction was structured to provide them with significant financial benefits: a newly built house worth $1.5 million and a cash sum of $250,000. From an objective consideration of the facts and circumstances, the intention behind entering into the transaction appears to be profit-making. Consequently, this would be considered a profit-making activity, and the proceeds would be treated as assessable income.
However, the transaction may also fall under Capital Gains Tax (CGT) provisions. John and Marie never purchased their primary residence with the intention to subdivide and make a profit. Generally, taxpayers pay income tax when they are carrying on a business, and the transaction occurs as part of their business activities. As highlighted in tax ruling TR 92/3, even an infrequent transaction in the course of business can be seen as a profit-making activity rather than a Capital Gain. In John and Marie’s case, they are not developers, nor are they running a business where this infrequent transaction can be seen as a sale instead of a Capital Gain Tax (CGT) event.
Determining whether John and Marie’s transaction with the developer is a profit-making activity or a capital gain is not straightforward. The outcome hinges on various factors, including their intention and the nature of their involvement in the transaction. While there are elements suggesting it could be considered a profit-making activity due to the significant financial benefits and structured nature of the deal, there are also strong indications that it might be classified as a capital gain, given their non-business status and original intention behind purchasing their residence. Additionally, if their transaction is considered a capital gain event, there is the question of whether they would be eligible for a 50% capital gain discount. Ultimately, the specific activities and the context surrounding John and Marie’s actions will play a crucial role in determining the correct tax treatment of this transaction. Seeking professional advice is essential to arrive at a definitive conclusion.
Conclusion
John and Marie’s case highlights the complexities involved in property subdivision transactions, especially when exchanging part of a property for a new house and cash. There are numerous factors to consider, such as how the income tax will be treated, whether the transaction will result in a capital gain or income tax liability, the necessity to register for GST, and eligibility for a 50% Capital Gains Tax discount. Additionally, exploring strategies to minimize tax is another crucial aspect that readers should consider maximising their financial benefits.
Understanding what deductions are applicable when faced with a one-off income, like the subdivision of property where builders are paying all the expenses, can be puzzling for property owners and investors. These considerations can significantly impact the financial outcomes of such transactions. If you are facing similar challenges and need expert advice, contact Investax’s property tax specialists. Our experienced team can help you navigate the intricacies of property subdivision, ensuring you make informed decisions that optimize your tax situation. Reach out to us today to secure your financial future.
Reference
ATO – Taxable Sales
ATO – Barter Transaction