Almost everyone dreams of being a property developer, whether it’s finding a great parcel of land to build townhouses or subdividing the land they’re currently living on.
But what are the tax implications of property development?
Ignoring those who develop properties for a living (i.e. people who regularly buy and sell, or develop multiple properties) and focusing on “mum and dad” types, property development generally falls into one of two categories:
- Profit making scheme
- Investment in a passive rental asset to earn rental income.
Let’s look at each one in turn.
- Profit making scheme
A profit made from an isolated transaction is only considered a profit making scheme if both of these statements are true:
- The intention or purpose of entering into the transaction was to make a profit or gain
- The transaction was entered into, and the profit was made, while carrying on a business or in carrying out a business operation or commercial transaction.
Here are a couple of examples the Australian Taxation Office (ATO) would consider to be profit making schemes:
- A taxpayer acquiring a block of land and building two townhouses for resale.
- A taxpayer subdividing their backyard and building a house or unit for resale.
For tax purposes, profits from a profit making scheme are taxed as ordinary income. The general capital gains discount of 50% isn’t available on development activities—even if the land has been owned for more than 12 months after committing it to the scheme. And the profit is taxed in whatever tax year the property is settled.
- Mere realisation of a capital asset
If the property wasn’t sold as part of a property development business or a profit making scheme, the sale is considered a mere realisation of a capital asset.
Here are some examples of what would typically be considered a mere realisation of a capital asset:
- A taxpayer selling a main residence or long-term investment property.
- A taxpayer selling an office building or factory used in their business.
- A farmer subdividing and selling off farming land, provided they do just enough preparation of the property to realise the best price possible—and no more. (Note: This may not be true in all cases.)
For tax purposes, the profit from a mere realisation of an asset isn’t considered ordinary income. Instead it falls under the Capital Gains Tax (CGT) regime. If the property is held for more than 12 months, the 50% CGT discount applies and the taxpayer will be taxed on only 50% of the gain. Small business CGT concessions may reduce the gain even further if the asset being disposed is considered an active asset. And the profit is taxed in the tax year sale contracts are executed and exchanged, even if the proceeds of the sale aren’t received until the following financial year.
- A development that involves construction is likely to be considered a profit making scheme, unless the intention is to hold the property as a long-term passive rental property.
- A development that involves subdividing land only is likely to be considered a mere realisation of an asset.
What about GST?
The ATO considers the sale of new residential premises a taxable supply for GST purposes if the taxpayer is registered (or needs to be registered) for GST. Generally, this happens when their income from taxable supplies exceeds $75,000 per year.
If a new residential premises is disposed of under a profit making scheme, it’s considered a taxable supply for GST purposes. If this pushes the taxpayer’s income above $75,000 (which it almost certainly will) they will need to register for GST and remit GST to the ATO on the sale of the developed residential premises.
To offset the GST payable, they can claim GST incurred while constructing the developed property, less an adjustment if the property is rented before being disposed of.
However, if the new residential premises is disposed of as a mere realisation of a capital asset it is not considered a taxable supply for GST purposes. That means that if the taxpayer’s income doesn’t exceed $75,000 they won’t need to register for GST or remit GST on the sale of the developed residential premises to the ATO.
Obviously taxpayers will want their sale profits from development activities to be considered a mere realisation of a capital asset so they can take advantage of the CGT provisions and avoid GST. However, in most circumstances (especially if the development involves construction) the disposal of the asset will be considered a profit making scheme and taxed as ordinary income. And GST will then come into play if and when the new residential premises is disposed of.
If you’re considering any property development, get in touch with your Client Services Manager at KLM Accountants to make sure you understand your income tax and GST obligations.