Subdivision Project - CGT Question

A mate and I want to purchase a large piece of vacant land with the purpose of getting a DA, OP works, and then subdividing it and selling the new lots of land.

We are looking to purchase as a unit trust, but the accountant we saw said we wound not be eligible for any CGT discount, even if we wait 12 months before selling.

Example situation
Land purchase cost (incl stamp duty) - $200k
Civ Works (excl gst) cost - $100k
Council fees (3 new lots) - $78k
Consulting/Misc - $22k

Now let's say we subdivide into 4 lots and sell each land for $150k, net sales = 4x$150k = $600k
Let's say we use the margin scheme, and pay GST on the $400k (ignoring input credits), therefore GST = 36k.

Therefore total realisations = $600k - $ 36k = $564k.
Total Dev cost = $200k + 100k + 78k + 22k = 400k
Return = $564 - 400k = $164k
% Return on TDC = 41%

Now obviously the numbers above are a bit made up, but my question is regarding the profit.

If I wait 12 months after purchasing the original land bought in unit trust before selling, is the $164k treated as capital gains and if so be eligible for 50% CGT discount?

 

no and no

 

Thanks for the reply, but can you explain why it IS NOT classed as capital gains?

The reason I ask is if I just bought a piece of land in unit trust for $200k, and did nothing to it, and sold it 13 months later for $364k, then that would be $164k of capital gains right? How is this different from a tax perspective?

 

See
Tax Tip 143: The sale of a property – Capital or Revenue account? Tax Tip 143: The sale of a property – Capital or Revenue account?

For some tips. And then get some advice on how you could try to make sure it was on capital account and not revenue.

 

This would depend on the circumstances.

 

Funny enough, I've gone through most your tips and they've been really helpful. Tax Tip 143 is a bit confusing, but essentially after reading the case, it seems like "The precise reason as to why controllers of the family trust eventually caved in and sold the property is not of paramount importance. As long as there was a clear change in circumstances strong enough to change the original intention (within reason), the original intention itself is all that is needed to determine the capital nature of an asset. "

Thus is it fair to reason you believe that any capital gains made is not applicable to the CGT discount is because the intention of us buying the land is to develop and make a capital gain, as opposed to just holding it and "selling it when the price was simply too good".

 

Mmmmm....


However, I understand in this case where we go in with the obvious intention to subdivide the land, it seems like on the surface any earnings would be treated as revenue. I'm struggling to see how it could be "on capital account and not revenue".

 

A better alternative is to implement the development through an appropriate form of joint venture. There are many documents called joint ventures that aren’t in the required format, hence the need for an ‘appropriate’ form of joint venture. Under such a structure, there is no transfer of property to the developer, therefore avoiding the imposition of stamp duty. At the same time, the landowner is considered to hold the property on capital account, therefore retaining the CGT advantages. In addition, the share of the joint venture that may be enjoyed by the landowner can be maximised, therefore maximising the CGT concessions.

The Right Structures For Property Development Mean Tax Advantages For You - Rouse Lawyers

This is actually a great resource too:


Worryingly, the ATO have recently reported they have found a “growing number of property developers that were misusing trusts and treating a property under development as a capital asset” incorrectly. Accordingly the ATO have issued Taxpayer Alert TA 2014/1 which describes an arrangement where property developers use trusts to return the proceeds from property development as capital gains instead of as ordinary income.

...

This is demonstrated by a recent court case, August v FCT [2013] FCAFC 85. In this case, the Federal Court held that income the taxpayers received as beneficiaries of a number of trusts was income according to ordinary concepts and not income of a capital nature because of the existence of a profit making intention on resale (accordingly the 50% CGT Discount could not apply). This is despite of the properties being held for a number of years and deriving rental income during the ownership period.

Property Development Tax Treatment - Capital Gains (50% Taxable) or Ordinary Income (100% Taxable) ? - CapitalQ

With all that in mind, seems incredibly hard to purchase the land and have profits be in the capital account, and not revenue... unless you do a joint venture between the trust and a development company.

 

What if you intended to hold it and gathered evidence as such?

You should review as many cases as you can, look through the private ruling database and try to work out what the ATO looks for when considering one way or the other.

 

Been going through a couple above incidentally, but that's a good suggestion. Boy are the ATO tough in being stingy in awarding capital gains tax provisions, and treating even one off incidental sales oftens as ordinary income. More often than not, the ATO defines profit made off selling subdivided property as ordinary income as opposed to capital gains revenue. Essentially what they look for are two things I believe: 1. whether your intention was to make a profit, and 2. if the sale is part of a property development business.

Looking at cases 1 and 3 below, the relevant parties had owned the properties for many years yet still had any profits taxed as ordinary income. Thus even if I

would that be of much use, given that didn't help Case 1 and 3?

1. Subject: Land subdivision and property development

The proceeds received on the sale of the two vacant blocks of land and the house and land package are assessable as ordinary income. While the activity is not considered to be a business of property development, it constitutes a profit-making undertaking or scheme (or an adventure or concern in the nature of trade) and is therefore considered an isolated commercial transaction conducted with a view to a profit.

The activities undertaken for the development go beyond that of a mere realisation of a capital asset as they involve significant change and value adding to the original asset.

RBA Content | Australian Taxation Office

2. Subject: Property subdivision and development - assessability of sale proceeds

In short, it is considered that there was no profit-making intention in originally acquiring the Land several decades ago. In addition, the current subdividing and development of the Land and related transactions do not have the character of business operations or commercial transactions. There is no indication that a separate business operation or commercial transaction has commenced. Consequently the proceeds ultimately received will not be treated as ordinary income and will not be assessable under section 6-5 of the ITAA 1997.

Since the subdivision and disposal of the Land is the realisation of a capital asset, the proceeds are not assessable as ordinary income. Any gain or loss made upon disposal of the subdivided lots will be subject to the capital gains tax (CGT) regime under Part 3-1 of the ITAA 1997.

RBA Content | Australian Taxation Office

3. Subject: Property - subdivision - development -Carrying on a business? - isolated transaction - mere realisation

You are not carrying on a business of property development because your activities do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. However, any profit or loss from the sale of the Sale Townhouse off the plan will still be accounted for on revenue account as an isolated commercial transaction because you are subdividing the Property and constructing the townhouse for the primary purpose of making a profit on its sale.
...
Accordingly, your activities will have the characteristics of a commercial transaction. As you will be carrying out an isolated commercial transaction with a view to a profit, the profit made will be ordinary income under section 6-5 of the ITAA 1997.

RBA Content | Australian Taxation Office

 

mere mental intention is not enough. You will need to show your intention and steps taken to that end.

Where you buy, quickly subdivide and sell this may be difficult.

 

This issue of intention and ordinary income is old law and predates the (modern) concept of capital gains. Buying land intending to develop / subdivide and sell any is an enterprise. Tax Ruling MT2006/1 considers that this enterprise must have a ABN and the nature of the enterprise intends to product ordinary income. Tax Law has always considered this a form of assessable (ordinary) income so that more modern concept of CGT law does not apply. Hence a CGT discount can never occur if a capital gain event is never considered to occur

This topic is addressed and explained in our developer toolkit. The same issue can also affect some very basis developmnets. eg Dave and May build a small lot of units to sell but plan to keep one as their home.That unit may not be able to use the main residence exemption under the ATO Ruling explained in the toolkit.

This disputed issue is quite clear and I find is the first concept all budding developers must address and accept. In many cases where property is to be partially sold and partially retained strategies to access possible capital gains often involve transfer to another entity (and paying tax at the time of transfer based on amrket values) which may then enjoy future discounted gains.

 

Welcome back Paul!

 

Thanks Terry - Slightly off thread but if anyone is thinking about Alaska its just an amazing place.

 

Seems like that's pretty much it, and that we have to come to accept that any subdivision project we undertaken will not be eligible for a CGT discount.

 

You might be interested in this booklet by Bantacs:
http://www.bantacs.com.au/booklets/How_Not_To_Be_A_Developer_Booklet.pdf

 

Tip : How not to be a developer. Dont buy land you intend to sell for profit.

There is a wonderful tax ruling...Google TD 92/135......Which is short and simple. It clearly demonstrates that ordinary income prevails over capital account and that can absolutely prohibit future use of a CGT discount if the original intent was related to income production.

It may be necessary that the developer sell to a distinct entity which intends to hold for capital account. Yes this will crystalise a profit but it does open the door to future CGT discount. No private rulings, no disputes.

 

Terry - My concern with the booklet is evident in the first line of the first paragraph.
This booklet is not for developers who regularly subdivide land...My emphasis added.

The ATO doesnt care about repetition and its not a factor in the quest for defining who a developer is. A single first event can constitute a business or ordinary income.,

 

Yes - everyone should still get specific advice relating to their situation.

 

Very quick question so I don't need to start a new thread.

If I buy the property as Company X as trustee for Y Unit Trust, can I ask for

Invoices, should they be address to:
a) Company X
b) Y Unit Trust
c) Company X as trustee for Y Unit trust


Moreover, if I open a bank account, do I need a trust account or a simple joint account assuming at the end of the day, there's two people behind this. So should the name of the bank account be:

a) Company X
b) Y Unit Trust
c) Company X as trustee for Y Unit trust
d) Mr A + Mr B

???

Cheers