You possess a piece of land that is ideal for a subdivision. All the necessary arrangements have been sorted out with the Council, builders, and the bank. However, a crucial aspect has been overlooked: the tax implications.

Many small-scale developers often assume that they will face minimal tax risk. Nevertheless, this assumption isn’t always accurate, as the tax treatment of a subdivision project can significantly influence cashflow and the project’s financial feasibility.

Recent guidance from the Australian Taxation Office (ATO) delves into the tax consequences of small-scale subdivision projects. Let’s explore some key points:

Tax Treatment of Subdivision: When subdividing land, the tax treatment, even for a small subdivision, can rapidly become intricate. Taxation depends on the specific circumstances. One should not presume that just because the development is small, any eventual sale profit will automatically be considered as a capital gain, qualifying for Capital Gains Tax (CGT) concessions.

Generally speaking, if you personally own a property that has been used for private purposes over an extended period and you divide and sell the newly created lots, capital gains tax may apply to any profit obtained. The gain is calculated from the moment you acquired the land, though you’ll need to divide the property’s initial cost among the subdivided lots. If you’re subdividing a property that includes your primary residence, the main residence exemption typically won’t apply if you sell a subdivided block separately from the main block, even if the land was solely used for residential purposes related to your home.

If a property is initially co-owned but then subdivided, distributing the lots among the owners, this usually triggers immediate tax consequences, even before selling to an unrelated party. Such arrangements, known as ‘Partitioning’, can be challenging to manage from a tax standpoint.

Property Development: What if you decide to develop the land? It’s quite common for individuals to subdivide and develop their property by constructing a house or duplex, followed by selling the new structure.

When someone develops a property with the intention of selling the finished product for a short-term profit, there’s a possibility that it will be treated as income rather than falling under capital gains tax rules. This may limit access to CGT concessions, such as the 50% CGT discount, and often result in GST obligations. This applies even to isolated property developments.

Illustrative Case: Let’s consider an example involving Conrad. He acquired his home in July 2001 for $300,000. By July 2020, he explored subdividing his property, constructing a new house, and selling it. A valuation revealed that the original house and land were now worth $360,000 (60%), while the subdivided lot was valued at $240,000 (40%). Conrad obtained a $400,000 loan for the development and sold the property for $1,210,000 (GST inclusive) in July 2021.

For Conrad’s situation:

• Conrad’s total economic gain was $580,000.
• This gain stemmed from sale proceeds ($1,100,000, excluding GST) minus development expenses ($400,000) and the initial cost of the subdivided lot ($120,000 which is 40% of the acquisition cost $300,000).
• The increase in value of the subdivided lot from acquisition (July 2001) to the start of profit-making activities (July 2020) qualifies as a capital gain.
• The capital gain for the subdivided lot ($240,000 in July 2020 minus $120,000 initial cost proportion of acquisition) is $120,000.
• With the 50% CGT discount (as Conrad held the subdivided lot for more than 12 months), the discounted capital gain is $60,000.
• The increase in value of the subdivided lot from the start of profit-making activities to the sale is treated as ordinary income.
• The net profit ($460,000) considers sale proceeds ($1,100,000) minus development expenses ($400,000), and the lot’s value ($240,000).

Unless Conrad is engaged in a business, he can’t deduct development expenses as they’re incurred; instead, they impact the net profit upon sale. If Conrad opted not to sell after development, it would complicate income tax and GST treatment.

GST Considerations: For individuals subdividing land held for private use, GST registration might not be necessary, depending on circumstances. However, engaging in a property development business or a business-like one-off project could require GST registration.

In Conrad’s case, since the projected sale price exceeded the $75,000 GST threshold, he likely needs to register for GST. This entails:

• A ‘default’ GST liability of $110,000 on the sale price (unless the GST margin scheme applies).
• Notifying the purchaser of the amount to withhold and remit to the ATO.
• Eligibility to claim $40,000 credits for GST within development expenses, adhering to regular GST rules.
• Reporting these transactions through business activity statements.

Should you please have any question in regards to above, please feel free to contact our friendly team in Pitt Martin Tax at 0292213345 or info@pittmartingroup.com.au.

The material and contents provided in this publication are informative in nature only.  It is not intended to be advice and you should not act specifically on the basis of this information alone.  If expert assistance is required, professional advice should be obtained.

By Robert Liu @ Pitt Martin Tax