With subdivision and small-scale property development becoming more common year-on-year, it’s important that you’re aware of any potential capital gains tax (CGT) and tax issues that may arise. This is particularly important for first-timers. There’s a big difference between simply selling your home, and selling property to make a profit.
In this article, we’ll have a look at the CGT regulations that relate to property development, and how this can impact you as an individual.
Thinking about property development? Contact a Liston Newton property accountant today to get the advice and guidance you need to reach your financial goals.
When it comes to developing your property, the CGT and tax regulations will make a big difference in the final outcome of your sale.
So it pays — literally — to be across them, right from the outset.
When developing and selling a property, it can fall into one of three different categories. Each of these categories will have an impact on your ability to claim the CGT reduction.
Your property can be categorised as:
- A profit-making scheme
- Disposal of trading stock
- A capital gain
Let’s look at what each of these categories means, and the CGT and tax implications for each.
A profit-making scheme
As an individual property developer, you’ll be considered to be carrying out a profit-making scheme if:
- The transaction or development was entered into with the intention of making a profit or gain
- The transaction or development was entered into while you were carrying out your business or acting in a commercial manner
So this means that if you buy a property with the sole intention of developing and selling it for a profit, then your business is considered a profit-making scheme.
Under this categorisation, any income earned from your property development is classified as your business’ income, rather than the sale of a single asset (like selling the family home). Any income from the sale is taxed as ordinary income, on a revenue account, and the relevant marginal tax rate will apply.
So, as the sale is considered as regular business income, and not an asset sale, you can’t claim the 50% CGT reduction on the sale of your property. This even applies if you’ve owned the property for more than 12 months.
Let's look at some examples. Your development would be considered a profit-making scheme if:
- You bought a parcel of land and built four apartments on it, each for individual sale, or
- You subdivide your family property and build a townhouse on it for resale.
On the flip side, it won’t be considered a profit-making scheme if:
- You buy a parcel of land, then three years later sell the land as you can’t afford to build on it, or
- You add an extension to the family home, then sell it in order to downsize.
Disposal of trading stock
If you purchase land for the purpose of reselling it, then ATO provisions may consider it as trading stock. This often occurs if your development takes on a business-like nature. This can include things like:
- You have a business plan for your property development
- The activities you undertake, like buying and selling land, is repeated and occurs on a regular basis
- You’re knowledgeable and have prior experience in property development.
Basically, if it looks like you’re buying and selling property in a business-like manner, then your actions will be considered as business actions. Thus, your development will be considered as trading stock.
From a tax perspective, though, this can be detrimental. Under trading stock provisions, any tax deductions for acquisition or development costs might not be deductible straight away. Instead, they’re likely to be deferred until settlement. So if settlement occurs in the next financial year, you miss out on those deductions for that year.
Your income is also assessed on revenue accounts, which means that your property sales are classed as business income. So, as with a profit-making scheme, the relevant marginal tax rates apply, and you can’t access CGT discounts on your sale.
As a property developer it can be difficult to have the sale of a property assessed as a capital gain. Your intent is to make a profit, which often leads to the sale being assessed as a profit-making scheme, or as trading stock.
However, if you sell a property that’s not part of your property development, then it’s not likely to be considered part of a profit-making scheme. Instead, it can be classed as a realisation of a capital asset.
So for example, if you privately sell the home that you live in, or an investment property, then this isn’t part of your business income. You’re selling a capital asset, which means that it can be assessed under the capital account, and will fall under the CGT rules:
- If you’ve held the property for more than 12 months, you only get taxed on 50% of the capital gain
- If the property is considered your main residence, the capital gain may be exempt from tax entirely.
A word on GST
GST is also an issue that you need to consider when getting into the property development space.
Taxpayers are required to register for GST if their income is set to exceed $75k in a financial year. Given the nature of property development, this is practically a given.
This means that GST is required to be remitted to the ATO upon the sale of your property. But it also means that you can claim GST on expenses throughout the development period. So things like contractors, building supplies, or education expenses (if you’re keen to learn about the industry), can all be claimed as a tax deduction.
However, this only applies if your property development falls into the profit-making scheme or trading stock category. You’re using the development to make money, so it’s considered as business. Therefore you need to register for GST.
If your property development is considered as a capital asset in nature, GST likely won’t apply, and no registration is necessary.
But with GST comes a whole range of other issues to deal with, particularly when it comes to understanding the sales process. Check out this article for more information about GST and property sales.
The final word
While property development can certainly be rewarding, there is a range of factors that you need to consider as an individual when entering the industry. Getting the wrong information or advice will have significant tax consequences down the track.
Proactive, accurate tax advice is critical to ensure that you understand your income tax, capital gain, and GST obligations, and to help you thrive in this exciting industry.