20 Sep Top Tax Issues When Subdividing Or Buying New Property
Investing in new property can seem like a daunting and risky prospect, while the development of existing property can turn out to be more complicated than just profiting off an unused bit of land. Your Investment Property asked Eddie Chung to clarify the pros of new property investment and the tax considerations involved in subdividing for development
Part A. Benefits of buying new properties as investments
A property investor generally has the choice of buying an existing or a newly constructed property as an investment. With the proliferation of off-the-plan apartments and house and land packages in recent years, many investors are now becoming more aware of the benefits of buying new properties as investments.
Benefit #1: Stamp duty
As stamp duty on the acquisition of a property is generally calculated with reference to the market value of the property at the time of the acquisition, buying a property off-the-plan can save you money. This is because you are not paying stamp duty on the constructed property at its completion value, but on the value of the land alone, which may prove to provide substantial savings.
Minimising your acquisition costs means that you are maximising your potential future capital gain on the property. However, beware that some state governments are now considering changing this to charge stamp duty on the final value of off-the-plan purchases, so it is important to get professional advice before you sign any contracts so that you know what the stamp duty cost will be in your circumstances.
Benefit #2: First homeowners grant
A number of states and territories provide some form of first homeowners grant to new homeowners, although some of the grants only apply to the purchase of newly constructed properties and not second-hand residential properties.
For instance, the Queensland government currently provides its First Home Owners’ Grant of up to
$20,000 for the purchase of new properties (up until 30 June 2017).
Naturally, the grant is not available to property investors or people who have owned properties before, but if you buy the property as your first home, it may be the incentive that catapults you into property ownership. Not to mention that you may be able to convert the property into an investment property at some point down the track, such as when you are in the position to upgrade your home.
Benefit #3: Tenant appeal
Most people are attracted to the gloss of brand new products, and real estate is no exception.
A new investment property complete with all the mod cons may appeal to more prospective tenants than older properties, which underpins your rental income as a landlord. And as residential vacancy rates are rising in some parts of the country, owning a new investment property as opposed to an older one may just be the difference between quickly securing a tenant and having the property sit vacant for months on end as tenants ﬂ ock to newer properties instead of yours.
Benefit #4: Lower running costs
The modern equivalent of traditional building materials together with contemporary construction designs and practices often mean that newly constructed properties are more energy efficient than older properties.
“Some state governments are considering changing this to charge stamp duty on the final value of off-the-plan purchases”
While this may not directly help you as the landlord, as most running costs associated with an investment property are borne by the tenant, it may indirectly enhance the tenant appeal of your property, if you market those energy efficient features effectively as part of your tenant procurement strategy.
Telling a prospective tenant that they can slash a third of their power bill by moving into your property instead of an older one makes a compelling case when electricity costs are at an all-time high.
Benefit #5: Lower repairs and maintenance costs
Unlike running costs, repairs and maintenance costs are normally the responsibility of the landlord. Provided there are minimal defects in the construction of the property, a new property generally requires far less repairs and maintenance as everything is brand new.
This will give you a ‘honeymoon period’ where you will only incur minimal repair and maintenance costs compared to that of older properties where wear and tear start to accelerate. If you like to be a ‘set and forget’ type of investor, a new property may be a better choice for you, at least over the first few years of your ownership.
Also, it may be worthwhile to check if your new investment property is still under construction warranty. If so, you may be entitled to ask the builder to make good any defects if any structural problems surface during the warranty period.
Benefit #6: Higher depreciation deductions
Provided that all the freestanding depreciating assets in the property (eg, stove, clothes dryer, etc) are new, you could potentially claim a higher amount of tax deduction for depreciation on them under the ‘diminishing value method’ of depreciation in the earlier years of the effective life of the assets, which will provide a better tax outcome for you during those years.
Benefit #7: Longer remaining capital works deduction
Similarly, in relation to capital works deduction, which is attributable to depreciation on the building and structural improvements that are permanently affixed to the land, a new property will generally have a higher amount of remaining construction expenditure that may, in the future, be claimed as capital works deductions.
“The more extensive your history of developing properties in the past, the more likely it is that you will be seen to be undertaking a one-off proﬁt-making undertaking”
In most cases, a new building is eligible for capital works deduction over the next 40 years (if the property is put to income-producing use), as opposed to if you buy, for example, a 35-year-old building, where you may only be able to claim capital works deductions in the next five years before the unclaimed capital construction expenditure runs out.
Part B. Tax issues of subdividing your property for development
As more and more land around city centres becomes a scarce commodity, many people who own homes on large blocks are looking into the idea of subdividing their land as a one-off project in order to make money.
Generally, once you have subdivided land from your block, the subdivided blocks will no longer be treated as your main residence. Therefore, sale of this land will generally be subject to tax. However, the manner in which any gain you derive will be taxed depends on your speciﬁc circumstance.
Capital gain or income?
The threshold question in determining the tax treatment of a subdivision and development project is whether any gain or loss you make will be taxed as a capital gain or income.
As a general proposition, any gain you make from the mere realisation of a capital asset is taxed as a capital gain. If the property has been held for at least 12 months by an individual or a trust by the time it is sold, the capital gain will be eligible for the 50% CGT discount, which will effectively halve the tax liability on the gain.
In contrast, if the gain you make constitutes a one-off profit-making undertaking, it will be fully taxed as income without any CGT discount. So, how do you work out if your arrangement is a mere realisation of a capital asset or is considered a one-off profit-making undertaking?
As with many tax issues, there is no hard and fast rule in drawing that distinction. It is a question of fact and you need to consider all the facts and weigh them up to reach an ‘on balance’ conclusion. No one factor determines it.
“As with many tax issues, there is no hard and fast rule … you need to consider all the facts and weigh them up to reach an ‘on balance’ conclusion”
Thankfully, there are various tax cases in the past to provide some guidance on where the line of demarcation is drawn, which are supported by a taxation ruling issued by the Commissioner of Taxation. The indications to look out for include the following:
• Your intention for the subdivision – the absence of a profit motive (eg, you subdivide the land to reduce it to a manageable size) may cast doubt as to whether or not the project is a proﬁ t-making undertaking, but the presence of a profit motive does not by default preclude the possibility that the project represents a mere realisation of a capital asset
• The extent of work done – the less you physically do in subdividing and developing the property before it is eventually sold, the less likely that it will be treated as a profit-making undertaking, even if professional advice has been sought
• The level of sophistication in the way project is handled – the more systematic and business-like the project is conducted (eg, selling the property under an elaborate sales campaign through a project marketer as opposed to using a local real estate agent), the more likely it is treated as a profit-making undertaking
• The manner in which the activities are conducted – the more contractors and professionals involved in the project, the more likely that it would be characterised as a profit-making undertaking
• The size, extent and complexity of the project – the larger the scale and complexity of the development (eg, a property development that involves multiple stages), the more likely it is treated as an isolated profit-making arrangement
• The amount of borrowed funds committed to the project – the more borrowed funds are committed to the project, which means that you are exposing yourself to more risks, the more likely that you are carrying on a one-off proﬁt-making undertaking
• The ownership period of the property – the longer the property is owned, the stronger the argument that the sale only constitutes a mere realisation of a capital asset
• The history of the developers’ activities – the more extensive your history of developing properties in the past, the more likely it is that you will be seen to be undertaking a one-off profit-making undertaking; in fact, if you continuously undertake one project after another, you may be treated as carrying on a recurrent property development business.
In conclusion, if your situation is less than clear cut, it may be advisable to work with your tax adviser to formulate a ‘reasonably arguable position’ paper, which may substantially reduce your exposure to potential penalties if the taxation ofﬁce successfully challenges your tax treatment of the project.
is partner, tax and advisory, in the Real Estate & Construction division of BDO. Eddie has been with BDO for 20 years and a partner since 2006.
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