Subdivide, develop and then rent or sell … what are the tax implications?
This is a very common question and there are two scenarios at play here:
Scenario 1. Subdivide, develop and then rent
Let’s say we’ve subdivided the land, and built a new house on it with a view to rent that house out. Are there any capital gains tax implications on this? The answer is no, not at least, until we sell it.
What is vitally important is to keep records of our rental income and associated expenses – e.g. council costs, interest on the development loan, and other costs for the rental property; they will need to be included in our taxation return.
As it’s a new property, we will be able to claim depreciation on the building costs. I encourage you to go somewhere like BMT, and get a depreciation report so that you can claim those costs on an ongoing basis.
The taxation point for Capital Gains Tax is actually when we sell the property.
How do we work that out the capital gains?
As we discussed in previous articles, we need to look at the land first. Go back to when the land was first bought and allocate the cost for the portion of the subdivided land. Let’s say that’s $200,000. We then add the building cost at say $300,000. So now we have a cost base for the property for tax purposes of $500,000.
But remember, if we have been claiming depreciation, we have to decrease that value. Let’s say the depreciation is $100,000 on the property. We now have a cost base of $400,000. so if we sell it for more than $400,000 that is going to be a Capital Gain.
If we have owned the property for more than 12 months we’ll be able to halve the Capital Gain, but that will still need to be included in our tax return, and that will be taxed at our marginal rate of tax.
Scenario 2. Subdivide, develop and sell straight away
With this scenario we have the intention to make a profit and so there are two things we need to be aware of. Firstly, we’ve gone beyond just subdivision – we’ve gone beyond ‘realisation’, which is doing the minimum for the subdivision. The ATO now treats this as an income-generating activity and it is our intention to do it for profit. Therefore any profit that we make must be included in our income taxation return – 100% of the profit gets included in our tax return and it gets taxed at our marginal rate. No 50% discount like in scenario 1.
We also need to be aware of GST. If we sell the land and the house for more than $75,000, we must register for GST – just like any other business – and GST will be remittable on the sales price … but we will also get to claim back GST on the development costs. Plus we can also take into account the margin scheme, which I will cover in another video, to help reduce the amount of GST that would be payable to the ATO.
How do we know which scheme we fall under? The ATO has a basic rule of thumb called the ‘five year rule’. If we sell the property within five years, their view is that we’ve done this to make a profit. Therefore it will be assessed under income tax and GST will be applicable.
If we hold it for more than five years, we go down the Capital Gains Tax path, and only pay tax on 50% of the profits.
Be aware that the ATO looks at what our original intention is. So for example, if we developed this property to rent it out but due to financial difficulties, had to sell it, then we can actually go the the ATO, ask for a ruling, and they will come back typically and say that we can go down the Capital Gains Tax path. But remember, that is a once-off thing! If we keep going back to the ATO, they will treat us like a developer and put us down the income taxation path.
This can be tricky to wrap your head around, so if you’re considering either of these two scenarios, talk to us first so you can be ahead of the game and know what to expect.