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Please note in advance that any article about property development will be inadequate and insufficient to describe in full detail all of the tax consequences that can occur.
One of the most complicated matters in tax is property development. However more and more people find themselves in developing property as a shortage of land coupled with decreasing family sizes, a desire to live closer to population sizes and people looking to split blocks off their current property to cash in have created new classes of developers.
The important questions to consider going forward are (a) what was your intention on purchasing the land? (b) have you done this sort of thing before? and (c) how complicated is this development?
This is most certainly a brief guide limiting itself to residential property accomodation and land. Anyone seeking specific answers to their situation should see their accountant. This is a must as in many situations each development usually attracts a "common sense" approach by a seasoned accountant familiar with the cases that have governed property developments in the past.
To start off with, those who sell land or property fall into one of three categories - Mere Realisation, Profit Making Venture or Business.
Mere Realisation
There is a saying "Life is what happens to you when you are making other plans." Well, to put a spin on that saying, a mere realization would be "A profit that you receive while making other plans".
The following are typical examples of mere realization -
A farmer selling lots off his land gradually with limited activities involved (Casimaty)
The purchase of land intended to be used as a home, but subsequently sold when plans changed.
The purchase of a residential property that is subsequently resold for a profit.
Profit Making Venture
Your intention going in was to make money. You bought a house to sell off at a profit. You bought land to resell at a profit.
The following are typical examples of PMVs
A farmer actively involved in selling large amounts of lots subdivided from his old farmland (Statham)
The purchase of land where the intention is to resell for a profit.
Business
For those who are actively and consistently involved in buying, developing and selling property.
Examples of a property development business
Large property builders (eg Devine Homes, BMD)
So, which one are you really?
To make things less complicated than they already are, follow the simple flowchart here and follow the options until you work out where you stand. Click on it to enlarge.
(Bow in glory to my MS Paint skillz.)
Once you have found out where you stand, check out this table.
|
Mere Realisation |
Profit Making Venture |
Business |
| Profit |
Capital Gains |
Income (maybe some CG) |
Income |
| GST? |
No |
Yes* |
Yes* |
| Interest deductible during construction? |
Yes |
No |
Yes |
* GST does not apply to the sale of residential premises that is not new (or considered new under GST legislation if it has been substantially renovated) or sold after being held for five years where it was considered new.
New Residential Premises
The Government intended to make sure that GST did not enter into the housing market for normal home owners so with the introduction of the GST, it introduced the concept of New Residential Premises. If a property is considered to be new residential premises, GST can apply on sale. A property is considered to be New Residential Premises if (a) upon sale, there a house on that land that wasn't there before or (b) an existing property has been substantially renovated to the point where it can be considered to be a new residential premises. The only two ways to get out of having to charge GST is to (a) sell it after holding it for five years or to (b) not have the seller registered for GST at the time of sale and for the property in question to be considered a capital asset on sale. This is because capital assets are excluded from the GST threshold test, and normally the sale of anything over the threshold attracts GST.
Moving from mere realization to profit making venture
A property development that starts to grow beyond the definition of a mere realization and starts to fit the definition of a profit making venture has some extra complications. The first problem is that at the time the property development is committed to, the land is considered to convert to trading stock under the views in TD 92/124. Why is this bad? CGT Event K4 is triggered, which is that land is considered to be disposed of and reacquired for its market value. However, the person can also be considered to have disposed of the property at cost which would create a deduction of $350,000 (not a CGT loss under s118-25(2)) and a subsequently declared as closing stock on hand at the end of the year (ie income). But be careful - any profit on the disposal of trading stock when the land is disposed of is not capital gains, it is ordinary income.
Example
Jane has a block of land she purchased for $200,000 in 1996 that she intended to live on one day. In 2006, she decides to subdivide and sell off the land in such a way that it is a profit making venture. At the time she starts the venture, the land is deemed to be valued at $500,000. When development costs of $100,000 are incurred, the land is then sold for a value of $750,000 in 2007 (we will not look at GST here to make the example simple.)
What is her best option to reduce tax?
Using Cost.
Jane decides she doesn't want to pay tax in 2006 and chooses cost. The land is considered disposed of in 2006 for $200,000 and reacquired as trading stock. She then sells it in 2007. Her taxable profit in 2007 is $750,000 - $200,000 (trading stock cost) - $100,000 (development costs) = $450,000 as ordinary income.
Using Market Value (K4)
Jane decides to use market value even though it involves a taxable gain in 2006. The land is considered to be disposed of and reacquired at its market value and a capital gain is derived of $300,000 ($500,000 - $200,000). She can reduce it to $150,000 as she can apply a capital gains discount. Note - if it was farmland, she could reduce it further if she can meet the conditions of the small business CGT concessions such as the active asset reduction).
Jane then sells the land in 2007. Her taxable profit is $1500,000 in this year ($750,000 - $500,000 trading stock value - $100,000 development costs)
Total gain - $300,000.
So in the end, Jane will not pay as much tax by using market value, but she will have to pay some tax earlier.
What if the land was purchased pre-CGT?
Jane would have to be silly not to apply market value since the capital gain would be tax free. If she applied cost, she would pay tax on $450,000 instead of $150,000 (the gain on the sale of the land).
Final Word
Each development has little quirks that make them different from others so always seek the guidance of your accountant in these matters. This guide should make you familiar enough with the concepts so speaking with your accountant should be much easier, you are also aware of where you are headed and you are warned as to the tax treatment of what will happen depending on what actions you take.
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