Selling New Build after 5 years

I encounter a number of people who read in our developer toolkit (attached) about strategies around GST.
1. GST applies to sale of new residential premises
2. The margin scheme can be used to reduce the GST often by 50%+
3. They can claim GST on build costs in some cases;
4. They can sell after renting for 5 years and GST isnt involved.

Some take this a little too literally and think that waiting 5 years means there is automatically no GST. A recent case before the AAT demonstrates the limitations of taking this road. Personally I dont recommend it. It means the GST on the build cannot be claimed and it exposes the seller to all risks of the GST being recovered. The recent AAT case of FKYL and FCT contained all of this (and a taxpayer who obviously didnt seek advice from day one or even before appealing)

Taxpayer was a sole trader (mistake one) who bought land in 2003 to develop. She built 4 dwellings. At time of completion she tried to sell them but encountered issues meaning she chose to delay sales. Marketing for sales at her nominated price continued for a period of time. She planned sales and marketing for the 5 year period to expire and just prior listed them for sale. All sold.

The ATO considered she didnt meet the requirements of the 5 year rule contained in s40-75 of GST law. She thought they did qualify meaning the properties now 5 years old did not meet the definition of "new residential premises". Her problem is that s40-75 contains a limitation....the premises must have ONLY been used for making input taxed supplies ie rented. She had them available for sale after completion, while tenanted and also towards the end of the 5 year period. The ATO felt she didnt quite meet the 5 years. She acted too soon. Her view was the properties were five years old...Thats not what GST law says.

But seems the taxpayer wasnt well advised as she also didnt sell the properties using contracts that contained the margin scheme rules ïn the event GST was to apply to the sale" (a normal legal clause) as she considered the property exempt. And so her contracts resulted in full GST on the sales. The ATO were generous and allowed the tax credits to be claimed (only 80%) but imposed penalties, interest etc.

Tip : If planning to sell using the five year rule get advice BEFORE deciding. Then ensure the period of tenancy well exceeds the 5 years and attempts to sell are not made too soon. Also plan in your costs for no GST tax credits to be claimed. IMO combining the margin scheme and claiming the credits can virtually eliminate GST. The key lesson is dont "plan" around the 5 year rule. It doesnt really save a developer money unless you are a long term owner and intend to produce income for many many years.

 

On a side note the "juiciest" Depreciation is in the first 5 years of a new build too. Can a QS weigh in on this?

 

The QS deductions claimed erode the costbase which would result in a extra $1 of profit for each dollar of deductions claimed. Profit taxed as ordinary income. QS deductions will "bring forward" tax benefits. ie higher deductions in Y1-5 and then a higher profit in Y6.

That said it is easily argued that if you compare two projects side by side a property with high QS deductions likely has a better finish and condition and would attract a higher price / sell faster etc. Avoiding QS deductions by buying a shanty wouldnt be a strategy for capital growth.

 

Hi Paul,
What if the developer builds a house and moves in immediately afterward, then lives in it for a year, then rents it out for 4 years. Would this be a capital gains asset upon sale and eligible for the main residence exemption, or would it be classed as revenue? I'm guessing that once again it has to do with intent at time of construction.

 

It can depend on the circumstances. The ATO might argue the developer is just waiting for the market to jump before selling so it could be on revenue account still.
Generally speaking though the longer it is held the more likely you will be able to argue capital account. Even developers have to live somewhere.

 

Better still ...I am selling my older properties I have held for at least 7 years.

I plan to keep my new ones for at least 5 or more years. More likely I will keep them as the peak of depreciation sweet spot is about 7 years in...though 5 years plus is also good.

In your example...she marketed them initially mistake....just make a clear decision.

Issue is people have no exit strategy....mistake again.

 

Thanks Terry. Let's say I build a new house, move into it for 6 months, then rent it out for 5 years. During those 5 years I keep on building other houses and selling them for profit. Would this be likely to negatively impact the ATO's view of my 'main residence' and for them to treat it as income rather than a capital gain? I'm not sure what sort of evidence is required from the ATO's perspective..

 

Not enough to say, you need to get specific tax advice.

 

Haha I figured... if you would only take on some more new clients, I would be paying you for this advice! thanks for all the help on the forums anyway

 

Useful to know you can sell a property referencing accessing the margin scheme "in the event GST was to apply" as a mitigating strategy.

What is the length of time you can go back and claim the GST credits? I think it is four years (so selling between 4-5 years is worse than selling within 4 years).

 

Tax credits for each quarter would expire at 4 years. They would elso be eroded by the new residential premises formula where the premises are rented in the 4 years as well.

Note you cant easily use the margin scheme if the contracts for sale doesnt specify use of the margin scheme.