Taxing property developments; the ultimate guide

What’s the difference between a property developer and a property investor?

Property developers are in the business of acquiring, subdividing and selling land or acquiring and renovating property with a view to profit. The key things that indicate that someone is a property developer include:

  • Land is acquired with the purpose of making a gain on resale, or in the course of carrying on a business
  • You have a history of developing land or acquiring and renovating property for profit
  • You undertake extensive work on your land, including installation of drains, construction of parks, lakes, footpaths, roads etc
  • You have a high degree of personal involvement in your property activities
  • You carry out your transactions in a business-like manner

By contrast, property investors acquire land as an investment with the intention of using it to earn assessable income (such as business income or rent). Some development may occur but this is usually with a view to increasing the capital value of the land as it is retained for the long term. So:

  • You acquire property for investment and not for resale
  • You hold property over a lengthy period of ownership

How are property transactions taxed?

There are three ways in which profits from land transactions may be subject to income tax:

  • On capital account as a result as the mere realisation of the property
  • On revenue account where your development constitutes the carrying on of a business of property development
  • On revenue account where the development goes beyond the mere realisation of the land but is less than the carrying on of a business. The transaction is instead taxed as a profit making undertaking arising from an isolated transaction

In addition, GST may apply in different ways depending on the type of transaction. Let’s look in more detail at each of those possibilities.

Sale subject to Capital Gains Tax (CGT)

A sale of property will be subject to CGT where it is a “mere realisation” of the property.

Provided the property has been held for 12 months or more, the 50% CGT discount will apply, effectively halving the tax rate on the gain. In addition, other concessions may apply such as the small business concessions or the main residence exemption, which can potentially eliminate the gain altogether

This tax treatment will not apply where the property is acquired for resale at a profit or for development. The typical scenarios where a property transaction will be subject to CGT include:

  • The sale of a main residence (though note that where a block is subdivided, the main residence exemption will not apply to sale of the vacant block if the residence itself is not sold at the same time to the same purchaser)
  • The sale of primary production land
  • The sale of an investment property, including a holiday home
  • The sale of property used in a business

The CGT event occurs at the date sale contract is entered into, not at the date of settlement.

Where the contract date and settlement date are in a different year, you do not need to include the CGT event in your tax return until settlement occurs (though may choose to do so). Once settlement occurs, you must go back and amend the tax return for the year the contract was entered into within a reasonable period and include the gain in that return.

Running a business of property development

If you are running a property development business, your profits will not be subject to CGT. All profits from the development are instead on revenue account.

As the development continues, trading stock (being the value of the land any development) needs to be valued at the end of each income year at either cost, market value or replacement value. If the value of trading stock at the end of year is higher than at the start, the difference is assessable income. If the value of trading stock at the end of the year is lower than at the start, the difference is deductible.

Certain development costs are included in the cost of trading stock (meaning that a deduction is effectively deferred until sale) such as:

  • Cost of materials
  • Direct labour costs
  • Production overhead costs (such as depreciation)
  • Infrastructure costs (eg, costs to establish services on the land and build roads)

Other costs are immediately deductible, such as:

  • Administration expenses
  • Interest on loans
  • Rates and other taxes

Isolated profit-making transactions

If you undertake an isolated profit-making transaction (such as a one-off property deal that you don’t intend to repeat), profits from the development are also on revenue account.

The profit from the development is treated as ordinary income at the date of settlement. Development expenses are offset against proceeds from sale with net profit assessable at settlement.

Holding costs (rates, taxes, interest, etc) are deductible as incurred

The key difference to being treated as a business is that any profit from the venture is not taxed until realisation whereas a business of property development will have a profit or loss each year through the course of the development.

Goods and Services Tax (GST)

Many property developments will give rise to GST consequences. Essentially, GST will become an issue if the seller is required to register for GST.

The registration criteria are twofold:

  • The entity is carrying on an enterprise. An enterprise includes an activity, or series of activities, done in the form of a business or in the form of an adventure or concern in the nature of trade. An isolated transaction can constitute the carrying on of an enterprise.
  • The entity’s annual turnover meets the registration threshold, currently $75,000

Most property transactions will beat the turnover threshold so the question of whether to register usually hinges on whether the seller is conducting an enterprise. Where a subdivision and sale of land is a mere realisation of a capital asset (and hence subject to CGT), that would not normally constitute the carrying on of an enterprise hence there would be no obligation to register for GST, pay GST on sales and no right to claim input credits on costs.

Where the seller is already registered for GST and the property is an asset of the business, the position is different. Even though the disposal is a mere realisation, the disposal will be a taxable supply and GST will still need to be accounted for on the sale.

If the seller is conducting an enterprise and is required to register for GST, the following GST implications arise:

  • The sale of commercial property or new residential premises (including off-the-plan sales will be a taxable supply.
  • GST will be payable on the sale of the property, calculated at 1/11th of the GST-inclusive sale price of the property.

Note that from 1 July 2018, most purchasers will be required to pay a withholding amount from the contract price at the date of settlement. This applies to:

  • new residential premises
  • land that could be used to build new residential property (‘potential residential land’).

The withholding amount is paid directly to the ATO rather than to the property supplier. The seller must notify the purchaser in writing as to whether or not they have a withholding obligation.

Use of the ‘margin scheme’ can reduce any GST arising on sale if conditions are met. To use the margin scheme, there must be an agreement in writing with the buyer that the margin scheme will apply.

The margin scheme is available if one of the following conditions is met:

  • the property was originally acquired before 1 July 2000;
  • the property was originally acquired through a taxable supply to which the margin scheme applied; or
  • The property was not originally acquired through a taxable supply, for example:
    • the property was acquired from an entity that was not registered for GST (or required to be registered for GST),
    • The property was acquired under a supply of a going concern
    • The property was acquired under an input-taxed supply

Under the margin scheme, GST is payable on 1/11th of the ‘margin’, rather than the GST-inclusive sale price. The ‘margin’ is generally the amount by which the GST-inclusive sale price exceeds the original cost of the property.

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