Are you considering a development as your next venture within the world of property?
Have you reviewed your potential income tax and GST liabilities?
Clients who are building new residential properties, whether intending to keep the property and rent it out or to sell for a profit, are often unaware of the potential tax implications. When I inform clients of the potential tax implications of selling they are often quite surprised that GST could apply and they wouldn’t necessarily be eligible for CGT discounts.
In recent years there have been a couple of cases where the ATO have determined property sales to be profit making, rather than realisation of capital assets so it is important to ensure you have discussed your plans with your accountant and you are fully aware of the potential tax consequences.
How the sale of the new property is treated for tax purposes all comes down to your original “intention” at the initial time of purchase (and the ability to prove this intention to the ATO). Proof of your intention may include items like email correspondence with your accountant and minutes of meetings.
There are three possible outcomes and subsequent tax implications:
Merely realising an asset: CGT
(sale of investment property)
Once-off profit making scheme: CGT, GST and Income Tax
(build a single property with intention to sell)
Serious development: CGT, GST and Income Tax
(multiple properties built and sold)
Capital gains tax AND income tax can apply to situations where the property purpose has changed. For example, lets say you purchase a property and rent it out for a few years, you then approach the council and are told you can build four townhouses on the land. It is at this point, when the “purpose” of the property changes, that the property changes from being a capital asset, to being trading stock, and a CGT event occurs. The value for CGT then becomes the cost for the land trading stock to ensure you are not taxed twice.
Ron & Brenda own an investment property in the Melbourne suburb of Ashburton. They have been renting this property out for five years and are now trying to decide what to do with it.
They have three options:
- Sell as is. The sale of the property will be subject to capital gains tax. As they have owned the property for more than 12 months they will be entitled to the 50% discount.
- Subdivide the backyard, build a new property and sell both with the intention of making a profit. As with option 1, selling the existing home will be subject to CGT and the 50% discount will be available. Selling the back house will most likely require registration for GST (as the new house is being sold within the first five years of construction) and the profits will be subject to income tax. The margin scheme may also be able to be used to reduce the GST liability.
- Submit plans to council, obtain permits and build 5 townhouses which they sell. Ron and Brenda are now in business as developers. At this time, when their land changes from being a capital asset to trading stock on hand they have a CGT event. They will also have to account for GST and income tax on the profits, and again they may be able to use the margin scheme.
The margin scheme is applied to reduce the amount of GST payable on the sale, and is based on the difference between the purchase price and the sale price. When using the margin scheme you are still entitled to claim the credits for any GST you have paid to your suppliers. Keep your eyes open for a future article explaining the margin scheme in more detail.
As you can see, there is a lot to consider. Whether you are planning a large development or a one-off build, not understanding the tax implications could be very costly.
Venturing into the world of property development can be quite complex so please give Paris Financial a call so we can advise you on all the potential tax implications ensuring you have the best advice possible before making any decisions.
Rebecca Mackie, Partner, Paris Financial