Property investors who subdivide land face complex tax issues.
Purchasers of land can generally be divided into four categories:
- A home owner who purchases land with the intention to live there
- A property investor who purchases land with the intent to generate income from the rental
- A property speculator who purchases land with the intent to produce a profit from its resale in the near future, with minimal input and
- A property developer who purchases land with the intent to improve the value by subdividing the block or constructing buildings, then selling at a profit.
The home owner and property investor will be deemed to hold the land as a capital asset. Any gain realised on the eventual sale will be included in the investor’s taxable income under the capital gains tax rules.
The taxation issues to be considered will vary according to whether they are tax residents and include eligibility for the 50 percent discount for assets held for more than 12 months, cost base calculations and the main residence exemption for a home owner particularly where they own more than one residence, whether the property has been used at some time to derive assessable income or if the property is over 2 hectares.
It is important to note that land that is divided from the main residence and sold separately is not subject to the main residence exemption.
This compares to the property speculator and property developer who will both be deemed to be holding the land as a revenue asset, with the full amount of profit realised on the sale being included in their taxable income as ordinary income, regardless of how long they have actually held the land.
The taxing issues that arise include the expenses that can be claimed as a tax deduction when incurred and those that have to be included in the cost of the property, the allocation of costs to the subdivided property, the timing of recognition and calculation of profit as the subdivided property is sold.
The distinction between the different categories of land purchaser is generally based on their intentions at the time of purchase.
Generally, if an investor merely takes the minimum steps necessary to subdivide, then sells the land, they will continue to be considered an investor, with the sale treated as a capital asset.
On the other hand, if a property developer were to demolish existing buildings, and subdivide the land, the profit would be fully taxable even if houses were constructed on the land and even if the houses are rented for a period of time.
A common situation is where the land holder’s intention changes over time – perhaps due to the purchaser’s circumstances and the property market.
This change in status will also result in the land changing from a capital asset to a revenue asset or vice versa. As of that date, there will be a deemed sale and acquisition of the property for tax purposes.
The deemed sale proceeds will be equal to the market value of the property at the time of the change in use for the property developer. The investor is able to choose either market value or cost. Each choice has its own consequences.
If the investor chooses the current market value as the deemed sale proceeds, they will realise a capital gain equal to the difference between this value and the cost base.
This capital gain will be eligible for the 50 percent discount, before being included in the owner’s taxable income.
This market value will then be used as the purchase price when determining the profit realised on the property development. This profit will be calculated as the difference between the actual sale proceeds and the sum of the development costs and the market value used to calculate the capital gain. This profit will be taxed as normal income of the land owner.
Whilst the property owner will be able to crystallise the benefit of the 50 percent CGT discount by choosing this option, they will realise a tax liability that may need to be paid at a time when most of their cash is tied up in the property development.
If the property owner were to choose the original cost of the property as the deemed sale proceeds, there will be no capital gain realised on this deemed transaction as the sale proceeds will be equal to the cost base.
Instead when the property owner ultimately sells the newly constructed houses, the taxable profit will be calculated as the difference between the sale proceeds and the sum of the development costs and the original purchase price.