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Navigating Tax Implications and Pitfalls of Property Subdivisions

You’ve got a block of land that’s perfect for a property subdivision. The details have all been worked out with the Council, the builders, and the bank. However, there’s a crucial aspect that might have escaped your attention: the intricate web of income tax, Capital Gains Tax (CGT), and Goods and Services Tax (GST).

Many property investors and small-scale developers often assume that they understand their tax exposure. They sell the properties after completing subdivision, knockdowns, and rebuilds, claim a 50% CGT discount since they held the property for more than 12 months, and apply the Primary Place of Residence (PPOR) exemption on the other one since they lived in the home before the knockdown.

However, it’s not as straightforward as it sounds, and the tax treatment of a subdivision project can have a significant impact on cash flow and the overall financial feasibility of the project. New guidance from the Australian Taxation Office (ATO) walks through the tax impact of small-scale subdivision projects. We look at some of the leading issues below:

Tax Treatment – Property Subdivision

The tax treatment of even a small subdivision can become complex very quickly, and taxe applies according to the circumstances. You cannot simply assume that just because it’s a small development, any profit from the eventual sale will be taxed as a capital gain and qualify for CGT concessions.

Property subdivision

In general, if you own the property personally, it has been held and used for private purposes over an extended period, you subdivide it, and you sell the newly created block, then capital gains tax is likely to apply to any gain you make. The gain is recognized from the point you first acquired the land, although you will need to apportion the amount paid for the property between the subdivided lots.

If you are subdividing a property that contains your home – the main residence exemption will not generally be available if you sell a subdivided block separately from the block containing your home, even if the land has only ever been used for private purposes in connection with your home.

If a property is initially owned jointly but the property is subdivided and the lots are split between the owners, then this will normally trigger upfront tax implications even though the land hasn’t been sold to an unrelated party yet. Arrangements like this (referred to as partitioning) can be complex to deal with from a tax perspective.

Developing a property

But what happens if you develop the land? It’s not uncommon for people to decide to subdivide and develop their block by building a house or duplex and then selling the new dwelling.

When someone develops a property with the intention of selling the finished product at a profit in the short term, there is a risk that this will be taxed as income rather than under the capital gains tax rules. This limits the availability of CGT concessions (such as the 50% CGT discount) and will often expose the owners to GST liabilities as well.

This can be the case even for one-off property developments. Let’s consider an example involving Mark. He purchased his home on 1 July 2005 for $350,000. In June 2022, Mark started exploring the idea of subdividing his property and constructing a new house to sell. A professional valuer’s assessment of the subdivision indicated that the original house and land now hold a value of $420,000, and the subdivided lot is valued at $280,000 (the valuation is an essential step taken before commencing the project to avoid potential disputes with the ATO).

Mark decides to proceed with building a dwelling on the newly subdivided land and secures a loan of $450,000 for the development. His plan is to repay the loan once the house is sold. In August 2023, Mark successfully sold the subdivided lot and the newly constructed home for $1,430,000 (including GST). Here’s how the tax calculation works in Mark’s scenario:

  • Mark achieved an overall economic gain of $710,000.
  • The total gain ($710,000) is based on the GST-exclusive selling price ($1,300,000, assuming the GST margin scheme is not applied), minus the GST-exclusive development expenses ($450,000) and the original cost related to the newly subdivided lot, which amounts to $140,000 ($350,000 × 40%).
  • The increase in value of the newly created subdivided lot from its original acquisition date (1 July 2005) until the commencement of profit-generating activities (1 June 2022) is treated as a capital gain.
  • The value of the subdivided lot when Mark began profit-making activities on 1 June 2022 was $280,000. The initial cost attributable to the newly created subdivided lot was $140,000 (40% × $350,000) on July 1, 2005, resulting in a capital gain of $140,000.
  • Because Mark held the subdivided lot for more than 12 months, he is eligible for a 50% CGT discount, resulting in a discounted capital gain of $70,000.
  • The increase in value of the subdivided lot from the beginning of profit-generating activities until the time of sale is considered ordinary income.
  • The net profit ($570,000) is calculated by subtracting the GST-exclusive development expenses ($450,000) and the value of the subdivided lot ($280,000) from the GST-exclusive sale proceeds ($1,300,000).

If Mark is not involved in a business, he cannot claim deductions for the development expenses as they are incurred. These expenses will be factored into determining the net profit upon sale. If Mark finished the development but decided not to sell the property, then this would complicate the income tax and GST treatment. We would need to explore what Emily plans to do with the property.

Do I need to register for GST?

If you are an individual who is subdividing land that has been held and used for private purposes, then you might not need GST, although this will depend on the situation. However, if you are engaged in a property development business or a one-off project that is undertaken in a business-like manner, then it is more likely that you would need to register for GST.

In Mark’s case, since the anticipated selling price of the developed land surpasses the GST threshold of $75,000, he will likely need to register for GST. This implies that he:

Will have an initial GST obligation of $130,000 on the sale price of the developed block. However, there could be a chance to lower the GST liability by applying the margin scheme.
Should inform the buyer about the specific amount to be retained and remitted to the ATO during the settlement. Is eligible to claim GST credits of $45,000 for the GST incorporated within the development expenses (in accordance with regular GST rules). Is required to document these transactions by completing business activity statements.

In conclusion, while embarking on property subdivisions and development projects can hold great promise for financial gains, it’s essential to recognize the intricate web of tax implications that accompany these ventures. If you are contemplating engaging in a subdivision venture or other property development activities, we encourage you to get in touch with us. We are here to guide you through the potential scenarios and assess the tax impact of your project.

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