You’ve got a block of land that’s perfect for a subdivision. The details have all been worked out with Council, the builders, and the bank. But, one important aspect has been left out; the tax implications.
When you undertake any subdivision of land that is not part of a property development business, even if it includes your family home, you need to understand when:
- any gains or losses are treated as a gain or loss of income or capital
- an activity is considered to be carrying on an enterprise for ABN and GST purposes
This is not applicable if you are involved in property development and purchased land in the course of your business.
Tax treatment of the subdivision
Subdividing land
The tax treatment of even a small subdivision can become complex very quickly and tax applies according to the circumstances. You cannot simply assume that just because it’s a small development, any profit from the eventual sale will be taxed as a capital gain and qualify for CGT concessions.
In general, if you own a property personally, it has been held and used for private purposes over an extended period, you subdivide it and sell the newly created block, then capital gains tax is likely to apply to any gain you make.
If a property is initially owned jointly but the property is subdivided and the lots split between the owners, then this will normally trigger upfront tax implications even though the land hasn’t been sold to an unrelated party yet. Arrangements like this (referred to as partitioning) can be complex to deal with from a tax perspective.
Developing a property – What happens if you develop the land?
It’s not uncommon for people to decide to subdivide and develop their block by building a house or duplex and then selling the new dwelling.
When someone develops a property with the intention of selling the finished product at a profit in the short term, there is a risk that this will be taxed as income rather than under the capital gains tax rules.
This limits the availability of CGT concessions (such as the 50% CGT discount) and will often expose the owners to GST liabilities as well. This can be the case even for one-off property developments.
The ATO has provided guidance on the tax implications of this type of subdivision in the example below.
Example: Claude’s one-off profit-making subdivision activity
Claude purchased his home on a single title from a private seller on 1 July 2001 for $300,000. The house was situated on the front portion of an 800m² block. Claude wished to remain in this home however maintaining the big backyard became a burden.
On 1 July 2020, Claude began detailed research and spoke with multiple local real estate agents to understand if he could subdivide his backyard to build a new house and sell it.
Claude’s registered valuer valued the entire property at $600,000 split 60% | 40%:
- original house and land – $360,000
- newly created subdivided lot – $240,000
Claude decided to subdivide, build a house, and sell the newly created subdivided development. To do this, he:
- lodged an application for subdivision and received council approval
- engaged a project developer to:
- prepare and submit a development application
- build the new house.
Claude funded the development expenses of $440,000 (GST inclusive) through a bank loan and expected the sale of the new house to pay the loan out in full.
He engaged a local real estate agent to sell the new house. He sold it via a contract signed on 1 July 2021 for $1,210,000. There is no agreement to apply the margin scheme to the sale.
Income tax outcomes
- Once the backyard got its own title, it became its own asset and was no longer part of Claude’s home as a domestic asset. Because Claude’s transaction is more complex than just selling the vacant lot, his activities amount to a development activity.
- The sale of the backyard became a profit-making activity once Claude made the decision to embark on that activity.
The net profit from that activity will be included in his assessable income.
Claude made an overall gain (net profit plus capital gain) of $580,000. This will be the assessable income he pays tax on.
The overall gain is calculated as follows:
- Proceeds of sale ($1,100,000 – ex GST) minus development expenses ($400,000 ex GST) plus the original cost attributable to the newly subdivided lot of $120,000 ($300,000 × 40%) equals $580,000.
The increase in the value of the newly created subdivided lot from when it was originally acquired (1 July 2001) up to when the profit-making activities began (1 July 2020) should be treated as a capital gain.
- The original cost, attributable to the newly created subdivided lot was $120,000 (40% × $300,000) on 1 July 2001.
- The value of the newly created subdivided lot at the time Claude began to undertake profit-making activities on 1 July 2020 was $240,000.
As Claude has held the subdivided block for greater than 12 months, he is entitled to a 50% CGT discount, hence there is a discounted capital gain of $60,000.
The increase in the value of the newly created subdivided lot from when the profit-making activities began up to the time of sale should be treated as ordinary income.
- The net profit ($460,000) will be based on the GST exclusive sale proceeds ($1,100,000) minus the GST exclusive development expenses ($400,000) and the value of the subdivided lot ($240,000).
If Claude is not carrying on a business, he cannot claim a deduction for the development expenses as they are incurred. They will be considered in determining the net profit on sale. If Claude finished the development but decided not to sell the property, then this would complicate the income tax and GST treatment. We would need to explore what Claude plans to do with the property.
Do you need to register for GST?
If you are an individual who is subdividing land that has been held and used for private purposes then you might not need to GST, although this will depend on the situation.
However, if you are engaged in a property development business or a one-off project that is undertaken in a business-like manner, then it is more likely that you would need to register for GST.
In Claude’s scenario, because the projected sale price of the developed land was above the GST threshold of $75,000, he will probably need to register for GST. This will mean that he:
- Has a ‘default’ GST liability of $110,000 on the sale price of the developed block, although it might be possible to reduce the GST liability by applying the GST margin scheme
- Needs to provide a notification to the purchaser of the amount at settlement to be withheld and paid to the ATO
- Is able to claim $40,000 credits for the GST included in the development expenses (subject to the normal GST rules), and
- Must report these transactions by completing business activity statements.
The tax consequences of subdivision and other property projects can be complex. If you are contemplating undertaking a subdivision and any property development activities, please contact us and we can help walk you through the scenarios and tax impact of the project.
Source: ATO – Tax consequences on sales of small-scale land subdivisions
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