Tax Effective Strategy for a development

We are building our first residential development, so... building the back unit first and retaining the front house that we currently live in.

Our intention is to move into the back unit after completion and make this our principle place of residence, we will then rent the front house and eventually sell off both houses. Our original loan is secured against the front house and the proposed loan will be secured against the front house and proposed unit.

If we decide to sell the unit, will this be subject to CGT? (this will be our home) and if we sell the front house as an investment will this be subject to CGT? I am assuming that once the unit is built the front house will lose value and the original loan will be highly leveraged against the front house, so no profit will made.. how can you account CGT on a house that has no equity?

Can some one please help clarify this?

 

This is a rather complicated topic.

 

I know confusing one at that..

 

Start with my developer toolkit. Then the questions that follow will be on point.

I wont hide it :
- Unlikely the main residence exemption may apply
- Or CGT discounts
- Ordinary income tax may apply
- GST might impact it

 

This is an area where I would definitely get very good specialist tax advice. I don't think it is something that you can DIY and get it right.

In terms of a general concept...

When you split the land, some of the value of the land will go to the front house and some will go to the back house. You need to divide the value of the land between each new block on a reasonable basis. What this means in practice is that although the value of the front house will reduce, it's cost base will also reduce, so a profit would still likely be made if you sell. I can't answer whether CGT would apply.

There is more info here:

Subdividing and amalgamating land

My advice is to get professional advice. Getting this wrong could cost you thousands or tens of thousands in additional tax which could be able to be reduced with proper advice. Proper advice is a good investment!

 

It is interesting that the value of the land can be allocated on a "reasonable" basis. So their is no prescribed way of apportioning value. This will give you the opportunity to be a little bit creative.

 

Yes definitely would like to discuss this with a specialist, want to get this right !
I also want to know whether its worth demolishing the front and building the next two units from a tax perspective. If anyone can help with this or refer me to someone that would be great, I am based in Perth and open to a meeting / phone discussion

 

I may argue that no taxpayer could reasonably apportion a site into two portions :
1. House and land and
2. Land
The general view adopted even by the ATO is that a valuer may need to apportion the historical costs into those two portions. Market valuation for tax purposes

Manipulation of values is of no regard if both are being sold and arising from a profit making intention. The valuation would be needed for the margin scheme is the trick to the OP question. The margin scheme prescribes the valuation methodology.

Apportioning is addressed in the dev toolkit also.

 

You can be as creative as you want to as long as the ATO considers your approach to be appropriate in the circumstances of the particular case. Some example are given in TD 97/3 but they pretty much boil down to an area basis or relative market value basis.

Legal database - View: Determinations (Including GST Bulletins): TD 97/3

 

probably also need to consider the trading stock provisions for the house currently being lived in when development starts.

many also forget Taxation Determination TD 92/135 which considers the interaction of ordinary income and the main residence exemption and provides that:

In cases where the sale of a dwelling gives rise to income under section 6-5 of the ITAA 1997, for example as part of a business or from an isolated profit-making transaction, that income remains assessable even if a principal residence exemption is available for CGT purposes.

It goes on to states that

• The principal residence exemption is a capital gains tax exemption only and does not extend to exempt from tax ordinary profits or business income.

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be extremely careful what you do to the main residence. you could tip it from being on capital account with the main residence exemption provisions into full on assessable income.

 

Yeh..I think I'll wait for our meeting Mike, I am utterly confused haha

 

The principal concern with the ATO expressed views in TD 92/135 is that the intention to use the property to produce income whether isolated, an enterprise or trading stock or whatever you want to describe it means the asset is not a CGT asset and so not exempt and not at discount.

Its wise for anyone who uses the word "develop" to remember that CGT is "new law" and that common law holds income to be produced on revenue account so that a CGT asset sale just does not occur.

Its one of the chief reasons why I produced the developer toolkit. I felt like a well worn record repeating the same view over and over. Some dont like what they hear but thats life and it often follows that if the CGT issue is wrong so is the GST one. I have had a few instances where a development which results in a later main residence being constructed and held as a remaining asset from a development as part of the overall project plan MAY be accepted by the ATO as being on capital account.

I cant recommend any more strongly - If you are doing a dev get advice from a property savvy tax adviser early in the piece. I get very worried by the numbers of people who start devs who don't understand the tax impacts...What type of plan do they have ? My view is tax should be part of the plan just as the council approval is.

 

Really happy you are getting advice.

 

Mike knows his property taxes. Good hands.

 

It is amazing how many people say "I just bought a development site, now what entity should I use to develop".

umm tax planning after the fact isnt called planning...

Blacky

 

Its like getting pregnant and then talking about contraception.

 

Couldnt have said it better myself.

 

And same outcome can occur in both cases.

 

Actually that may not be a good analogy because there are still many things that can be done if the contract is entered into in the wrong entity.

 

Doesn't the outcome of one occur prior in the case of the other?