Tax implications of converting family home to 3 townhouses

Hello all

I am after some (very) general advice regarding the following scenario.

Currently I have a family home worth approx $850k (fully paid off) and around $300k in savings.

The house was purchased in 2008 for $395k and has been my PPOR since that date.

I need to upgrade our house and I was considering of maximizing the amount of money available in our PPOR via knocking it down, and building three townhouses that would be immediately sold for an immediate profit.

The three townhouses would realise approximately $2.2 million with an estimated cost build of approx. $1 million.

So before tax is taken into account the two possible scenarios are;

1. Sell the family home as is and take the $800k + $300k in savings = $1.1 million

2. Develop the three townhouses and sell for $2.2 million - $1 million development cost + $300k in savings = $1.5 million

So before tax is taken into account building the townhouses would appear to be an approximately $400k better option.

However (and there is always an however) option 1 has no tax implications (as selling your PPOR is Capital Gains tax exempt)

But in developing the three townhouses I would be considered (I believe) to be undertaking a profit making activity and any profits realized would be taxed at my marginal tax rate (45%).

So if my profit from the development is $2.2 million sale - $1 million build cost - $395 cost of purchasing block in 2008 = $805k

Then 45% tax on this $805k profit is $362,250. Which reduces my end result for option 2 to $1,137,750

So when the income tax payable is taken into account both scenarios end up almost exactly the same! Obviously if this is the case there is no way anyone would go through all the hassle and stress of building the townhouses relative to just selling the house as is.

Essentially I am just after some general advice regarding whether the above is roughly correct.

My only thought about how the townhouse option would be worthwhile would be if I changed the cost base of the block from the original $395 I paid for it in 2008 to its current market value of $800k (however I imagine the ATO would not be happy with that!)

Obviously if I went ahead with the townhouse strategy I would seek specialist tax advice but if what I have outlined above is roughly correct then there is no point in following this strategy at all.

Cheers!

Malleybull

 

spend a few thousand on some good tax advice and consider options 3, 4, 5 and 6.

You might have deemed disposal when it goes from capital to revenue account with market value uplift.

Selling to a trustee or a company which could the undertake the development might be good, but will trigger duty.
A development agreement with a related entity also a possibility.
Lots of issues to consider.\
beware of unqualified advice too.

 

Thanks for your advice Terry

With regards to the following am I correct in interpreting this as meaning that once our principal place of residence is changed from a "capital" asset (i.e. the family home) to a "revenue" asset (for use in producing the townhouses) it undergoes a market value uplift from the $395k we purchased it for originally to the current market value of $800k?

You might have deemed disposal when it goes from capital to revenue account with market value uplift.

 

It could

INCOME TAX ASSESSMENT ACT 1997 - SECT 70.30
Starting to hold as trading stock an item you already own
(1) If you start holding as * trading stock an item you already own, but do not hold as trading stock, you are treated as if:.

(a) just before it became trading stock, you had sold the item to someone else (at * arm's length) for whichever of these amounts you elect:

cost (as worked out under subsection (3) or (4));

• its * market value just before it became trading stock; and

(b) you had immediately bought it back for the same amount.

 

I’m sure you’ve probably already thought of this but don’t forget to allow for time.
It will most likely take around 2 years to complete this. One of those years you will have nowhere to live and have to rent elsewhere.

 

Is it worth considering getting all approvals in place for the townhouses, then selling your house including approvals as a development project?

Absolutely no experience in this field so idea may not work.

 

The question that needs to be answered is whether this is trading stock or a capital asset and a profit from an isolated transaction. The timing of CGT events on those two scenarios are totally different

I always highly recommend getting a private binding ruling if you consider it to be trading stock as the implications otherwise can be a disaster !!

 

noticed you are in Melbourne....beware of development agreements to a landholder in Victoria as you might be subject to stamp duty under the economic entitlement provisions.

 

Its very important to determine if it is trading stock or not as the tax differences coulld be huge.

 

I have asked around on a number of different forums and most members have stated that $1 million for 3 townhouses is around the mark.

They would be mid spec townhouses (where my house is located wouldn't justify going high spec)

But as you say it is all the "extra" costs that add up!

 

Thanks, that is very sound advice.

If the ATO don't deem it as trading stock and instead treat it as a capital asset I could actually see a scenario in which I would actually end up in a worse position building and selling the three townhouses relative to just selling the house as is as a normal PPOR sale!

 

It could be worse because main residence exemption lost and cost base reverts back to value at purchase.