Subdividing and tax

Looking for some general advice around subdividing and the best way to structure for best use of tax and avoiding contamination.

I have a PPOR with about 120k useable equity. I want to release funds to purchase an IP and then also subdivide with the potential to develop the newly created block.

If I subdivide and develop and hold both properties I imagine there would be no issues. The subdivision costs would all be deductible.

It has however more likely I would subdivide and then sell the land or develop it and sell the existing property keeping the new townhouse as my own. In this situation I am unsure how the subdivision costs would be allocated? My concern is I have created a deductible loan and then sold off some of what it was used for?

Or am I confusing this more than it needs to be again

 

If you hold most of the costs wouldn't be deductible as they would be capital costs - assuming on capital account.

You would need to allocate costs between the 2 properties. If there are specific costs relating to one then to that property. If there are shared costs then apportionment.

Same with any loans. It needs to be apportioned between the 2 properties and once one has been sold that loan interest would no longer be deductible.

See
Tax Tip 93: Subdividing Property and Deductibility of Interest

 

Thanks Terry
So are you saying the interest on the loan I use to perform the subdivision would not be deductible?

For example I could either:
Loan A = 70k (Equity Release for IP purchase)
Loan B = 40k (Equity release for subdivision)
OR
Loan A = 110k (Both costs to purchase and subdivide)

If so and its not deductible what would happen an option2? Would that be a contaminated loan?

 

Nope, certainly not saying that! I was talking about the costs themselves.

 

The scenario I am thinking may look something like:

Purchase price of IP = 400k

Loan A = 100k (70k for deposit and stamps, 30k for subdivision)
Loan B = 350k (IP Loan including LMI capatilised)

Subdivision is completed at which stage I arrange a valuation which comes in at:
House Component = 300k
Land Component = 200k

Would I then need to refinance to pay out the existing loans and correctly split the loans?
Loan A = 270k (House)
Loan B = 180k (Land)

 

You've confused yourself!

If the purchase price was $400k with a $450k loan and it resulted in 2 properties you would need to apportion this $450,000 between those 2 properties.

You would need to engage a valuer to do this. Some of the land will relate to each portion while the existing house will relate only to 1 portion.

 

Definitely confusing myself but in my example that's what I thought I showed.
Total Loan size = 450k (100k and 350k).
Say the 100k equity used to fund the deposit and the 350k loan secured against the IP were also different lenders.

A valuer then values the subdivided lots as;
LotA which has the existing house = 300k
LotB which has the land = 200k

How is the loan structured so it is correct and correctly apportioned?

And I know this is probably a check with your broker but I like trying to understand as much as I can.

 

If that is the total value = $500k then Lot A represents 60% and Lot B 40%.

So split the loan into these portions:
1. $270k for lot A
2. $180k for lot B.

This is not a broker question, but a tax one so check with your tax lawyer or tax agent.

 

ThanksTerry, as always.
That is the figures I did use in my 5th post so glad I didn't confuse myself too much

The only part im not understanding from a finance perspective is splitting the loans because they are two seperate loans from different lenders.

 

But you didn't give the values.

 

Sorry I thought I had?

Loan A - 100k secured against PPOR
Loan B - 350k secured against IP

IP value before subdivision - 400k

Subdivision occurs and then a valuation is ordered. IP is now split into two parcels.

Parcel A - 300k contains house
Parcel B - 200k land only

As far as I know the 100k split against the PPOR and 350k loan secured against the IP are both now across both parcels so I need to split these to 60/40?

E.g:
Loan A secured against PPOR now becomes:
New loan A = 60k (house parcel)
New loan C = 40k (land parcel)

Loan B secured against IP now becomes:
Loan B = 180k (house parcel)
Loan D = 120k (land parcel)

 

You need to split the loans against their purposes. So unless there are specific expenses the loans should be split based on the valuations.

 

The interest may not be tax deductible in any event. Normally a developer can claim the interest as a deductible outgoing as it is incurred. The interest here may defer. And need to be treated as a adjustment to profit when that realises.

Detailed whole of project tax advice is a must. Some of the technical issues are explored in our developer toolkit which is draft. BeDeveloper is adding further information soon too.

 

Subdivision costs are never deductible. They may form an element of trading stock.

 

What about the interest on the loan used to subdivide investment properties though?

 

Paul is right - it all depends on the situation.

Assuming it was on capital account and your intention was to hold then the interest would generally be deductible.

 

If you dont have an income from the dev the deductible interest may defer under the non-commercial loss rules. These may be affected by issue of a business v's one off expectations of profit. Ordinary income rules may not allow offset of interest costs incurred in the nature of profit making against other income. Neg gearing applies to passive income.

You need tax advice - if you make assumptions you will make costly errors.

 

Why is it never easy

 

Because there are so many variables!

 

It is somewhat easy but its really not a DIY area of tax. It is what has led me to develop the Developer Toolkit and offer a initial consult so that the whole project has a tax plan.

What throws people is assumptions and applying what appears so clearcut as a fact. Developing is a highly complex area of tax law. I reckon its taken me 10+ years to get closer to understanding.