Tax Tip 243: Deemed Capital Gains without Selling – Development Risk

When an asset goes from being held on capital account to being held on revenue account this will trigger a capital gains tax event without the property being sold. It is CGT Event K4 and the capital gain is the market value at this point less its cost base.

This means you can be taxed without selling.


Example

Homer has an investment property and bought it for $100,000 many years ago. He gets an urge to develop and starts planning for 8 townhouses to be built on the land with his intention being to sell them all when complete. At this point, the land might become trading stock, depending on the circumstances, and Homer could unknowingly trigger CGT event K4.

If the land is worth $500,000 at this point, and the cost base is, say, $130,000, that would be a capital gain of $370,000.

It might be 2 years before the project is complete so Homer could have to pay CGT even before he receives any income from the property.


Ouch!

 

K4 relates to when a asset starts being held as TRADING STOCK. This isnt always the case when a profit making intention arises.

Is Homer conducting a business ? Or a isolated profit making intention ?
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There is also a ATO agreed basis for deferral of tax in Homers case IF K4 is an isolated profit making intention. Many tax advisers dont know its available and may suggest tax liabilities are due far earlier than they need to be reported and paid. This needs to be carefully managed to ensure penalties and interest can be avoided.

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Agree with @Paul@PFI K4 only relates to trading stock.

This sounds like a profit from an isolated transaction. I dont think K4 would apply.

 

Yes maybe that example is not detailed enough but Homer becomes a developer at some point in time while already holding the property and the existing property became trading stock when this happened.
He commenced a business developing property with the purpose of holding the property being resale.

see Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as ‘trading stock’?