You have a piece of property that would be ideal for a subdivision. The Council, the builders, and the bank have all been consulted regarding the specifics. However, one crucial factor—the tax implications—has been overlooked.
Small-scale developers frequently believe that their tax exposure is minor; nevertheless, this is not always the case, and the method by which a subdivision project is taxed can have a big impact on cash flow and the project’s capacity to make money. The Australian Taxation Office (ATO) recently released new guidelines that detail the tax implications of small-scale subdivision projects. We check out some of the most important problems:
Tax Treatment of the Subdivision
The tax treatment even for a small subdivision can turn into complex and tax applies as per the circumstances. It doesn’t mean that because it is a small development, any profit that comes from the eventual sale will be taxed as a capital gain and eligible for CGT concessions. If you own a property, it has been used and held for private purposes over an extended time period, you subdivide it and sell the newly developed block, then capital gains tax intends to apply to any gain you make. The gain is identified from the time you first obtained the land, although you may need to apportion the paid amount for the property between the subdivided lots. If you are making a subdivision of a property that has your home – the main residence exemption will not be available if you sell a subdivided block separately from the block having your home, even though the land has only ever been used for personal reasons in relation to your home. If the land is owned jointly but the land is sub-divided and the lots divided between the owners, then it will trigger upfront tax implications even if the land has not been sold to an unrelated party yet.
Developing a Property
But what would happen if the property were developed? People frequently decide to divide and develop their block by building a house or duplex, and then selling the new residence. There is a chance that property development done to sell the finished product for a profit shortly will be taxed as income as opposed to capital gains. As a result, fewer CGT discounts (such as the 50% CGT discount) are available, and the owners are frequently subject to GST payments. Let’s examine a case in point. Claude paid $30,000 for his house on July 1st, 2001. In July 2020, Claude started looking into the possibility of partitioning his lot, constructing a new home, and then selling it. The original home and land are now worth $360,000, according to a registered valuer report on the subdivision, and the subdivided lot is now $240,000 (the valuation is a crucial step before beginning to avoid any disputes with the ATO). Claude makes the decision to proceed with the construction of a home on the freshly partitioned property and obtains a loan for the project in the amount of $400,000. When the house sells, he wants to pay off the loan. Claude sells the subdivided block and new home in July 2021 for $1,210,000 (GST- inclusive). Here is how the tax works in the case of Claude’s scenario:
- An overall economic gain of $580,000 has been made by Claude.
- The overall gain depends on the GST-exclusive sale proceeds subtracting the GST-exclusive development expenses and the original cost attributable to the newly subdivided lot of $120,000.
- The increase in value of the newly developed/created subdivided lot from when it was originally obtained up to when the profit-making activities started must be treated as a capital gain.
- The value of the newly developed sub-divided lot, when Claude started to undertake profit-making activities, was $240,000 on 1 July 2020. The original cost, attributable to the newly developed sub-divided block was $120,000 on 1 July 2001.
- As Claude has held the sub-divided lot for over 12 months he is liable to a 50% CGT discount.
- The increase in the value of newly developed sub-divided blocks from when profit-making activities started up to the time of the sale must be treated as ordinary income.
- To calculate the net profit, you need to subtract the GST-exclusive development expenses and the value of the sub-divided block from the GST-exclusive sale proceeds.
Claude can’t claim a deduction for the development expenses as they are obtained if he doesn’t carry on a business. If Claude decided not to sell the property after finishing the development, it would make income tax and GST treatment complicated.
Is It Necessary to Register for GST?
If you are an individual sub-dividing block that has been used and held for personal use, you might not require to register for GST, although it will be based on the situation. However, if you are involved in a property development business, then you would require to register for GST. In Claude’s case, because the projected sale price of the developed property was over the GST threshold of $75,000, he’ll require to register for GST. It’ll mean that he:
- Has a $110,000 “default” GST liability on the price of the developed block, but it would be able to lower the GST liability by using the GST margin method.
- Requires to give a notification to the buyer of the amount at the settlement to be withheld and paid to the ATO.
- Can claim $40,000 credits for the GST included in the development expenses.
- Has to report these transactions by completing business activity statements.