Capital Gains Tax (CGT) can be confusing even for the best of us. However, to determine how a gain from a subdivision is taxed, it all really comes down to is: “intention.” Intention is the magical word and can more often than not determine your end tax payable result.
If your intention is to realize the capital gain in a property then you will be taxed differently to if you intention is to make a profit in some form. For example, a property used as a main residence only was purchased in 2005 at $250,000; by 2013 the value had increased to $490,000. The owners subdivide the clock and then sell the vacant land. In this particular situation, the gain is capital – with a 50% discount available as it is a “mere realization” of capital. In this case, the cost base pf the vacant block would be based on the valuation from a valuer, the Development Application (DA) costs and any improvement required by council.
A factor to consider when subdividing is to do so only when you’re ready to sell, as it allows the owner to maintain the capital gain exempt status longer, as subdividing demonstrates intentions as it is solely to realize capital gains. Subdividing early and “waiting” is an indication of intention to a profit making undertaking and will not be viable for an exemption.
Furthermore, by knocking down the main residence before selling proposes significant changes to the character of the asset and may see CGT payable. Similarly, by registering for GST adds another factor into the equation can also be an indication of an intention to make a profit.
Here’s another scenario:
A couple acquire a house in 2012 and lodge a DA in 2013 to knock down the existing house, subdivide land and construct two townhouses. The intention of the owners is to occupy one as the main residence and sell the other one to help fund the main residence.
The owners have no background in building or associated industries and no history of property development. In this situation, the new main residence is exempt from CGT if it is established as the main residence and is occupied for a reasonable period of time (say three months). It must also be re-occupied within four years and the dwelling must be used for at least three months after completion.
If it is not treated this way, CGT will be apportioned over time owned; whilst the second townhouse will be taxed as business income.
GST implications include registration, GST on a portion of the sale price, credits on materials and services on purchase.
However, if the couple were to sell the vacant block without development it is likely to be a capital 50% discount. Nevertheless, constructing and renting out the second block shows intention of investment, which on a later sale may grant 50% discount but includes issues such as cash flow.
In fact, planning is critical. In some circumstances, the numbers may actually find the after tax position preferable with the sale of the second block vacant rather than developed. Keep in mind that the “intention” doesn’t have to be formally recorded anywhere and the tax office bases intention on the way that the actions are carried out.
For more information on CGT or other tax matters, contact one of our expert accountants on 02 9299 7044 or via firstname.lastname@example.org