Accounting for property development

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Accounting
By
Andrew Phelan
Andrew Phelan
Business Development Manager
October 1, 2020
6
minute read

A guide to understanding your accounting needs and obligations when developing property

Property development involves a whole lot more than simply sub-dividing and turning a profit. Developers need to think about things like renovating, re-leasing existing buildings, contracting builders and maintenance — the list goes on.

In short, if you're developing a property,  you'll be juggling many balls in the air at the same time — which makes it hard to consider the financial and accounting aspects. By hiring an experienced business accountant, you can eliminate some of the stress, and rest easy knowing your business is financially healthy.

Liston Newton Advisory is here to give comprehensive business advice on your new property development venture. Contact us today for a discovery call, and see how we can help start your business venture out on the right foot.

How to structure your property development

While there are numerous ways you can structure your property development, the two most important factors to consider are shareholder asset protection and flexibility in tax minimisation. The structures that best provide for these factors are the trust and company structures.

Company structure

A company structure is a formal business structure that acts as its own private entity. It features company directors, owners, and stakeholders, and every business decision must be agreed upon.

This structure is the most straightforward approach for a property development business. It allows its owners the flexibility to expand their property development activities, and bring new partners into the fold, while providing the legal and asset protection benefits of a separate legal entity. It can also take advantage of a capped tax rate, and well-defined governance processes that make it easy for members to enter or exit the business.

One downside of a company structure is that the structure has limited access to tax concessions —which is particularly important to note when it comes to capital gains tax.

Trust structure

A trust is a robust structure that enables a high level of asset protection and tax minimisation, without the rigorous financial reporting of a company. When set up properly, a trust can act as the ideal structure for families looking to hold property.

A trust structure enables you to distribute income generated by the trust among a selection of beneficiaries, effectively lowering the tax rate on any interest the trust earns. Trust structures are eligible for the government’s 50% capital gain tax discount, making it beneficial when buying, renovating, and selling property within a trust.

One big drawback of a trust, though, is the increased risk of audit. The ATO has a preference for property developments to be conducted under a company structure, not a trust, so its more likely to audit your business.

How to set up a property development business

Step 1. Create a business plan

Create a clearly structured formal plan for your business that outlines business goals, how you plan to achieve them, and the timeframe in which they must be reached.

Step 2. Set up your business and tax structure

Engage the services of an accountant and/or lawyer who can advise you on the most appropriate structure for your development.

Step 3. Create a bank account/s for your new business entity

Your accountant and/or financial adviser can provide guidance on the best type of bank account for your situation.

Step 4. Obtain finance pre-approval

If required, engage the services of a finance broker to get pre-approval for your first purchase.

Step 5. Set up the right insurance

Engage a business insurance broker to ensure your development is adequately covered.

Step 6. Set up your accounting software

A Liston Newton advisor can help you with your Xero file set up. External software can be integrated with Xero down the line to handle the job tracking and management, once you have multiple sites on the go at the same time.

Step 7. Determine HR processes

Ensure the appropriate policies and procedures are in place, as well as contracts for the future, by engaging a HR professional.

Step 8. Branding and marketing

If appropriate, consult with a marketing specialist to get your website, social platforms, and other marketing material sorted.

Step 9. Purchase your property

It’s time to purchase your property, and start making your property development work for you.

Step 10. Start planning

Start planning for your future purchases.

Dealing with GST

As a business, if your expected turnover is greater than $75,000 within a 12-month period, you’re required to register for GST. As a property developer, this is almost a certainty, so we recommend registering for GST at the outset of your business.

Usually, a transaction involving a residential property is input taxed, and therefore not subject to GST. However, as the type of properties you’re selling are most likely to be new, non-commercial residential premises, your income is subject to GST.

On top of this, property developers need to consider other GST issues, which include the margin scheme and GST at settlement.

Margin scheme

The GST margin scheme allows you to calculate GST based on the difference (the margin) between what you paid for your property and what it sells for.

If you were charged the full rate of GST when you purchased your properties, you can’t use the margin scheme. You can only use it if you purchased your property under the margin scheme.

Important things to note:

  • To use the margin scheme, both parties must agree to this in writing.
  • This scheme may be less attractive to buyers. It prevents their acquisition from being a creditable one, which means they can’t claim input tax credits for GST on their purchase price.
  • In GST Determination GSTD 2006/3, the ATO has stated it’s necessary to consider any settlement adjustments when determining the total consideration received. For example, if you receive an additional amount to cover council rates you paid, you’ll need to increase your consideration by that amount.

GST at settlement

1 July 2018 saw new GST obligations come into play for purchasers. Under this scheme, if you sell a property and you’re registered for GST, the purchaser must withhold the GST amount from the purchase price. They instead remit this directly to the ATO prior to settlement.

The amount they remit will either be the usual GST amount, or 7% of the purchase price if the margin scheme applies. As the supplier, you’re then entitled to a GST credit in your Business Activity Statement that’s equal to this amount.

In the circumstance where a group of people are purchasing, they each pay the GST sum proportional to their stake in the purchase.

Important things to note:

  • As the seller, you’re required to provide the purchaser with written notice, prior to settlement, advising whether or not they’re required to withhold this GST amount. If they are required to remit GST, you’ll need to include your names and ABN in the notice. This is a government requirement, so be aware that significant penalties apply if you fail to provide this notice.
  • If the purchaser is required to withhold the GST amount, but they don’t remit it to the ATO, they’re liable for a penalty equal to the withholding amount.

Capital vs revenue for income tax purposes

How you treat your profits makes a big difference in how you manage your income tax. There are significant differences between capital and revenue, and the impact each has on your business structure.

Example

  • Where the land or property has been bought and sold in order to make a profit, this will usually be considered revenue. As such, any property development costs are classified as trading stock, and form part of the cost of goods sold rather than a capital asset on your balance sheet.
  • But if land or property is a realisation of a capital asset, then it ideally wouldn’t be a source of income and would be classified as capital profit. You’ll then be able to access capital gains tax concessions on this sale.

However, intentions can change over time, and the ATO recognise this. If your initial intention is development, then the property is likely to be on your revenue account. But if that intention changes and your assets are held for capital growth or passive income, it can be changed over to capital later down the track.

How the ATO views it

Taxation Ruling TR 92/3 – Income tax: whether profits on isolated transactions are income remains the leading exposition of the ATO’s view on the capital vs revenue distinction. You can read it in more detail here.

Broadly, the ATO holds the view that profits arising from an isolated transaction — that isn’t part of your ordinary business activities — will be assessed as ordinary income.

The reasoning is that transactions will usually (but not always) have a profit-making intention when the property is acquired. Here are some key factors in the decision-making process:

  • The nature of the entity
  • The amount of money involved, and the magnitude of profit sought
  • The complexity of the transaction
  • How the transaction was carried out
  • Any connections between the two parties

Essentially, profit from the sale of your property will be considered revenue if:

  • You went into the transaction with the intent to make a profit
  • If you went into the transaction in the course of carrying out a business
  • The transaction was commercial in nature

Then, any subsequent disposal of the property is considered a realisation of the asset, and therefore considered as capital.

The final word

As you can see, there’s a lot that goes into planning your business development — particularly on the accounting side of things.

You need to ensure that your business is created under the most appropriate structure for your needs, and that it’s set up correctly. It’s not something you should jump into lightly. It takes thorough planning, a strong business plan, and expert guidance and support.

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