The taxing issues of subdividing your property
As more and more land around city centres is becoming scarce commodity, many people who own homes on large blocks are entertaining the idea of subdividing their land as a one-off project to make money.
Generally, once you have subdivided land from your block, the subdivided blocks will no longer be treated as your main residence. Therefore, their sale will generally be subject to tax. However, the manner in which any gain you derive will be taxed depends on your specific circumstance.
Capital gain or income?
The threshold question in determining the tax treatment of a subdivision and development project is whether any gain or loss you make will be taxed as a capital gain or income.
As a general proposition, any gain you make from the mere realisation of a capital asset is taxed as a capital gain. If the property has been held for at least 12 months by an individual or a trust by the time it is sold, the capital gain will be eligible for the 50% CGT discount, which will effectively halve the tax liability on the gain.
In contrast, if the gain you make constitutes a one-off profit-making undertaking, it will be fully taxed as income without any CGT discount.
Mere realisation or a one-off profit-making undertaking?
So how do you work out if your arrangement is a mere realisation of a capital asset or a one-off profit-making undertaking?
As with many tax issues, there is no hard and fast rule in drawing that distinction. It is a question of fact and you need to consider all the facts and weigh them to reach an ‘on balance’ conclusion. No one factor is determinative.
Thankfully, various tax cases in the past provide some guidance on where the line of demarcation is drawn, which is supported by a taxation ruling issued by the Commissioner of Taxation. The indicia to look out for include the following:
- Your intention for the subdivision – the absence of a profit motive (e.g. you subdivide the land to reduce it to a manageable size) may cast doubt as to whether the project is a profit-making undertaking but the presence of a profit motive does not by default preclude the possibility that the project represents a mere realisation of a capital asset;
- The extent of work done – the less you physically do in subdividing and developing the property before it is sold, the less likely that it will be treated as a profit-making undertaking, even if professional advice has been sought;
- The level of sophistication in which the project is handled – the more systematic and business-like the project is conducted (eg, selling the property under an elaborate sales campaign through a project marketer as opposed to selling it via a local real estate agent), the more likely that it is treated as a profit-making undertaking;
- The manner in which the activities are conducted – the more contractors and professionals are involved in the project, the more likely that the project would be characterised as a profit-making undertaking;
- The size, extent, and complexity of the project – the larger the scale and complexity of the development (eg, a development that involves multiple stages), the more likely it is treated as an isolated profit-making arrangement;
- The amount of borrowed funds committed to the project – the more borrowed funds are committed to the project, which means that you are exposing yourself to more risks, the more likely that you are carrying on a one-off profit-making undertaking;
- The ownership period of the property – the longer the property is owned, the stronger the argument that the sale only constitutes a mere realisation of a capital asset; and
- The history of the developers’ activities – the more extensive is your history of developing properties in the past, the more likely that you will be seen to be undertaking a one-off profit-making undertaking; in fact, if you continuously undertake one project after another, you may even be treated as carrying on a recurrent property development business.
In conclusion, if your situation is less than clear cut, it may be advisable to work with your tax adviser to formulate a ‘reasonably arguable position’ paper, which may substantially reduce your exposure to potential penalties if the tax office successfully challenges the tax treatment of your project.
Important disclaimer: No person should rely on the contents of this article without first obtaining advice from a qualified professional person. This article is provided on the terms and understanding that the author and BDO (QLD) Pty Ltd are not responsible for the results of any actions taken on the basis of information in this article, nor for any error in or omission from this article. The article is provided for general information only and the author and BDO (QLD) Pty Ltd are not engaged to render professional advice or services through this article. The author and BDO (QLD) Pty Ltd expressly disclaim all and any liability and responsibility to any person in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this article.